More 401(k) Options Mean Worse Outcomes

Plan sponsors have been protecting themselves from lawsuits by offering more 401(k) options, but at the expense of member participation and savings rates, a paper contends.

(May 15, 2013) - Investment options for a 401(k) retirement savings plan follow the classic economic tenet of diminishing marginal utility, according to a number of researchers.

And utility may hit its maximum at just one or two options.

Mercer Bullard, a securities law specialist and University of Mississippi professor, reviewed an array of published research on the efficacy of defined contribution (DC) plan structures. Then he added his insight as an attorney in the area. 

"Empirical research demonstrates that rational choice theory fails in the context of large 401(k) menus," Bullard found. "Large menus cause employees to make worse choices either by making inferior asset allocation decisions or not participating in 401(k) plans at all. Large menus also result in inferior options being selected by employers."

Increased complexity may provide a barrier to member participation, Bullard indicated. He cited a study by Columbia University researchers of over 800,000 people that found DC plan participation dropped on average from 75% to 70% when the number of available investment options rose from two to eleven.

The decline in enrollment was even more pronounced with female, low-income, and senior citizen employees.

Despite the very clear conclusions of this body of research, Bullard contends that courts have been incentivizing plan sponsors to offer large 401(k) menus.

"Some courts have dismissed claims against employers that offer a large number of investment options in their plans on the ground that, regardless of whether the employer acted imprudently, the legal cause of any resulting loss was the participant's choice of the option(s) in which to invest," Bullard wrote.

"These courts consider large 401(k) menus to offer a kind of marketplace that trumps employers' fiduciary obligations. This 'large menu defense' creates an incentive for employers to increase the number of options in their 401(k) plans in order to minimize their Employee Retirement Income Security Act [ERISA] liability risk."

He estimates that the "large menu defense" costs American workers billions annually in lost savings. 

Read Mercer Bullard's entire paper, "The Social Costs of Choice, Free Market Ideology and the Empirical Consequences of the 401(k) Plan Large Menu Defense," here.

Related Research:Why People Don't Buy Annuities: They're Confusing.

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