In just a few short years, the tax-advantaged, employer-assisted 401(k) retirement plan has become the hottest employee benefit around. Some 15 million workers sock away thousands of dollars a year apiece. Salivating over the prospect of managing all that cash, the financial-services industry has become a battleground as banks, insurers, and mutual-fund companies fight for the business. And while mutual funds are gaining the most ground, the war isn't over.
The average balance in 401(k) plans at major companies has soared from just under $9,000 to nearly $30,000 in the past five years. Assets under 401(k) management are expected to grow from $290 billion this year to $441 billion by 1995. Investing and monitoring those nest eggs generates juicy fees: According to Hartford-based consultants Access Research Inc., total revenues for providers of 401(k) plans come to about $1.5 billion and could grow to $5 billion by decade's end.
Money managers are increasingly reliant on 401(k) money. "It represents about 75% to 80% of our total institutional business," says Vanguard Group Senior Vice-President James H. Gately. No wonder there's a marketing war for new accounts. "I'm being bombarded left and right" with sales pitches, says Ellen Foody, benefits director at Greenville (S.C.) textile company Delta Woodside Industries Inc.
`REVOLUTION.' Named for a section of the Internal Revenue Service Code, 401(k) plans currently let employees save up to $8,728 of their pretax income toward retirement. Companies typically match the contributions by at least 50%, which is fully tax deductible. This saves them billions compared with defined-benefit plans. And employees get the dual benefit of tax deferral and company matching.
Companies are inviting more sophisticated and active money managers to compete for their 401(k) business. A new Labor Dept. regulation requires employers to offer at least three diversified investment options, to educate employees about those options, to disclose results regularly, and to allow frequent asset-allocation changes.
Employees will be the main beneficiaries. They are already seeing vast and rapid changes in the makeup of their plans, with more investment choices, more information, and more control. "There's a revolution going on in terms of the way these plans are being offered to employees," says Bankers Trust Co. Managing Director Allan C. Martin.
But employers win, too. On the one hand, they can unload the administrative headache of running the plans. At the same time, they can shift more of the expenses to their workers, because the fees paid to outside plan providers come out of employees' annual returns.
The big mutual-fund companies, such as Vanguard, T. Rowe Price, and Fidelity Investments, have set the tone in this competition. They brought their retail-marketing moxie to a historically conservative business. Insurance companies had an early grip on 401(k) business, since they underwrote the guaranteed investment contracts that used to be the staple of most 401(k) plans. Indeed, participants in the plans still invest most of their money in fixed-income products such as GICs.
FRANTIC INSURERS. But highly publicized problems at some life insurers--and declining returns on interest-rate-based products--are prodding 401(k) investors to switch more of their money into stock funds. "Plans traditionally have been dominated by company stock and GICs," says Richard N. Pallan, senior managing director at Putnam Cos. "That's not an appropriate asset allocation for younger investors." As more participants want to invest in securities, the old insurers could lose big. The mutual funds can provide daily valuation of account balances, toll-free telephone switching among investments, and customer service. Their approach has worked: In 1987, they commanded a 9% share of all 401(k) money. By 1992, that had reached 18%, and by 1997 it is forecast to hit 27% (chart).
But competitors are fighting back. Some insurers are changing their conservative ways. Aetna Life & Casualty, for example, is building up its mutual funds to compete more aggressively. Sun Life of Canada, meanwhile, is focusing on companies with fewer than 500 employees. That's a high-growth niche: While more than 9 out of 10 very large companies offer 401(k) plans, fewer than a third of small companies do.
Shearson Lehman Bros. Inc. recently won Labor Dept. approval to offer specific investment advice--such as how much to invest in bonds or stocks--to its 401(k) participants. "Over the next decade, we'll see most of this country's 401(k) business in the hands of a few big plan managers who can do it all--fund management, employee education, investment advice, and help with distribution decisions," says Jeffrey M. Miller, Shearson's director of retirement plan services.
PRETTY PACKAGES. Benefits consultants couldn't agree less. They are battling the one-stop providers by arguing that it's risky for a company to use one outfit for all of its needs, from record-keeping to money management. The consultants are pushing "alliances" that couple their administrative services with a smorgasbord of investments. Benefits manager Foody explains why she is leery of signing up with just one provider: "A lot of these groups are coming at us with a bundled package," she says. "I feel uneasy letting them take over everything."
An alliance arrangement appealed to Aluminum Co. of America. When Alcoa introduced its 401(k) in 1985, there were just three investment options: a fixed-income fund, a company stock fund, and a stock fund indexed to the S&P 500. That will change on Jan. 1, when Alcoa will begin using consultant Hewitt Associates for administration and bookkeeping, Mellon Bank Corp. as trustee, and Capital Management Corp. as money manager. Employees' three investment choices will grow to six, including one fund that invests in growth stocks and another in global equities.
Also thanks to the alliance, Alcoa employees will notice some state-of-the-art changes in processing, because Hewitt, Mellon, and Capital will share one mainframe data base for 401(k) management. Previously, workers had to change their investment-choice allocations by the 20th of a given month, then wait nearly two weeks for them to take effect. Now, Alcoans can submit changes by 4 p.m. on any given day and see the results the very next day.
The battle over 401(k) money doesn't stop when savers retire. In addition to signing up companies, money managers want to get their hooks into the employees themselves, so that retirees will stay loyal. At the rate today's 401(k) plans are growing, their nest eggs will just keep getting more alluring.