For 15 years, Lynda Hodgkiss maxed out her 401(k) plan, until she was laid off two years ago from her job as a mailroom supervisor for a health-care insurer. Unsure of what to do with her $220,000 nest egg, she turned to a financial planner near her home outside Tacoma, Wash. "I wanted to go to sleep at night and not worry that I'm invested in something I shouldn't be," she says. The planner advised closing her 401(k) account with mutual-fund giant Fidelity Investments and rolling over the money into an individual retirement account with brokerage Raymond James Financial Inc.
As the planner advised, she kept only 40% of the money in mutual funds, moving the rest to more conservative vehicles such as certificates of deposit. For the fund industry, the 55-year-old Hodgkiss is yet another customer slipping away as members of the baby boom generation begin wrapping up their careers and heading into retirement.
Surprisingly, for an industry just 20 years old, the 401(k) business is already over the hill. That's causing big headaches for mutual-fund companies, which administer half of the $3.2 trillion in workplace savings plans. When an employee retires or switches jobs, the industry manages to hold on to just 30 cents of every dollar in a 401(k) or similar plan. Now, the rate of rollovers out of fund companies is set to explode, from $198 billion in 2003 to $401 billion in 2010, according to market tracker Financial Research Corp. (FRC). The trend certainly isn't helping the country's falling savings rate, which has dropped from 4% to less than 1% over the past 10 years.
Indeed, the net inflows into workplace savings plans have been shrinking for a half-dozen years. The new money in them invested with fund companies, minus withdrawals, peaked at $80 billion in 1998 and totaled only $49 billion in 2003, according to the most recent data from the Investment Company Institute, the fund industry's trade group. The trend is even bleaker for the other half of the savings, which goes into money-market funds, CDs, annuities, and employees' company stock. That $1.6 trillion pool has suffered net outflows in four of the last five years, including $12 billion last year, according to Federal Reserve data. "The industry is almost out of the accumulation phase and into the distribution phase," says Fred D. Barstein, president of consultants 401kExchange.com Inc.
The flight from 401(k) accounts could speed up after July 1. That's when the oldest boomers turn 591/2 and are free to withdraw funds without a 10% penalty, even if they're still employed. Over the next five years, 16.3 million people will hit 60, according to the Census Bureau. Most will take their often-flush accounts with them when they retire. As a result, net inflows of retirement money to fund companies will keep falling, to an estimated $32 billion in 2010, according to FRC.
At the same time, fewer young people are signing up for 401(k)s. Instead, they're paying off steep college loans and credit-card debt and putting any spare cash into the hot housing market. The industry is pushing employers to enroll new workers automatically in 401(k) plans, but the outlook for this effort is uncertain because of labor laws in some states and fears of legal liability over putting workers into unsuitable investments. Even if more employers go along -- and about 10% do now, according to Mellon Financial Corp. (MEL) -- the extra contributions aren't expected to offset the big withdrawals by retirees.
All this is bad news for an industry that long relied on regular deductions from millions of paychecks to power its growth. The 401(k) plans at companies, 403(b)s at nonprofits, and 457s at state and local governments -- called defined-contribution plans because they don't have a guaranteed payout -- make up nearly 20% of the $8.1 trillion in assets held by mutual funds. But the rollover boom gathering steam, says William C. Carey, president of Fidelity's 401(k) unit, Fidelity Institutional Retirement Services Co., "is the biggest movement of assets that the financial-services industry will ever see."
What's particularly troubling for fund managers is how much 401(k) money they lose when a worker retires or switches jobs. Right off the top, ex-employees cash out almost 30%, says Chicago market researcher Spectrem Group. And just over half that money gets put into an IRA, with four out five of those dollars switching to a financial adviser, insurer, bank, or stockbroker. These competitors might keep some of the money in a mutual fund, as with Lynda Hodgkiss' account, but even so, they -- not the fund company -- get the lion's share of the lucrative fees that are charged. "It's a fight between the firms that have the assets now and those that have the offerings retirees are drawn to," says Chris Brown, director of retirement services research at FRC.
The big fund companies know they're the underdogs. Retirees like to roll over their 401(k)s because IRAs offer more investment choices, allow withdrawals for college expenses and other purposes, and provide more flexibility in picking a beneficiary. Says James M. Norris, head of the retirement business at fund giant Vanguard Group Inc.: "In many cases we just don't provide people with the right advice, products, or even tools. I don't think we've figured it out ourselves yet."
So Vanguard, Fidelity, and other fund companies are scrambling to capture a larger chunk of the rollover market. Vanguard, which offers some of the lowest-cost annuities for retirees seeking steady income, is looking to better promote its products by adding online planning tools for people nearing retirement, says Norris. Fidelity has been advertising a new program that consolidates all of a retiree's sources of income and expenses and then cuts a "paycheck" with taxes, insurance, and other costs automatically deducted and paid.
One firm, Principal Financial Group Inc. (PFG), a Des Moines insurer that also runs 401(k) programs, is more aggressive. Last year it started a pilot program that sends teams of investment counselors to workplaces to meet one-on-one with employees and help them plan for retirement. Still, this kind of education effort mixed with marketing can unnerve some employers who fear they may be liable if the advice turns out to be bad.
At the other end of the market, fund companies are desperate to sign up more younger workers in 401(k)s. The average participation rate, which peaked at 79% in 1995, fell to 70% last year, according to Mellon. Rates for the youngest workers are much lower: Only 26% of those under 25 were participants, vs. 31% in 2000; participation by 25-to-34-year-olds fell to 57% from 61%, according to Vanguard.
LAZY AND CONFUSED
The drop in part reflects a fear of stock investing after the three-year bear market. But it also coincides with the country's declining savings rate as more people borrow to buy real estate or finance consumption. In a survey by human-resources specialist Hewitt Associates Inc. (HEW), one of the top reasons employees gave for not participating in a 401(k) plan was that they couldn't afford to save more. "As a society, we haven't been saving at the rate we should be," says E. Scott Peterson, head of Hewitt's retirement-outsourcing business.
Automatic enrollment plans may be the answer to another problem highlighted by Hewitt's survey: that many people are simply too lazy -- or too confused by the options -- to sign up. When employees are automatically enrolled, participation rates have shot up because most were too idle to opt out. They also didn't bother to move their money out of basic funds. That scares some companies with automatic enrollment that they may be sued for putting employees into investments that are far too conservative. So the newest plans deposit the money into funds that try to match the investment's risks with an employee's expected retirement date -- putting more money in equities and less in bonds for younger workers, for example. Representative Bill Thomas (R-Calif.), chairman of the House Ways & Means Committee, is expected to give automatic enrollment a boost as part of the hotly debated Social Security reform bill this year, but passage of that measure is far from certain.
Automatic enrollment would help bring more dollars in the door. But unless funds find a way to keep the boomers in the fold short of barring the exits, the glory days of the 401(k) won't be coming back.
By Aaron Pressman in Boston