UPDATE 1-J.P. Morgan proposes new model for 401(k) plans

Wed Nov 9, 2011 1:45pm EST

*Three portfolios would replace 401(k) menu

*Target date funds would remain the default

*Some worry it will force active investors to pay more

By Jessica Toonkel

NEW YORK, Nov 9 (Reuters) -J.P. Morgan Asset Management is proposing that 401(k) plans slash the number of investment options they offer employees in favor of a new, more simplified model.

Currently, the average 401(k) plan has more than 18 investment options, on top of a series of target date funds, in which they usually automatically enroll new participants, according to McKinsey & Company.

Under J.P. Morgan's proposal, employers would still automatically enroll new participants into a target date funds. But rather than give those who opt out a choice of more than 18 funds, J.P. Morgan suggests providing three investment buckets: one that invests in a diversified portfolio of equity funds, one in bond funds and one in cash alternatives, such as stable value funds and money market funds.

The employees could allocate their contributions across the three portfolios as they see fit.

For example, the diversified stock portfolio would be made up of U.S. large cap equity funds, mid-cap equity funds, small cap, real estate investment trusts, international equity and emerging markets equity.

"For most investors in 401(k) plans, target date funds represent the best solution," said Michael Falcon, head of retirement for J.P. Morgan Asset Management. "But some people want more control, or they want to be more tactical or they just don't understand or trust target date funds."

OUTPERFORMANCE

Participants investing in a 401(k) plan with less than eight funds, not including target date funds, have outperformed those choosing among more than eight funds, according to J.P. Morgan research.

"Many times the investment options in a 401(k) plan are redundant or investors just don't understand them," Falcon said.

J.P. Morgan is discussing the proposal with advisers and consultants of large 401(k) plans, or those with more than $1 billion in assets, and hopes to see some plans roll it out in coming months, Falcon said.

The costs of the investment models vary depending on how the plan sponsor puts together the buckets and what kind of services are wanted.

Falcon declined to comment on the possible range of costs, but he did say they would be comparable to those of a customized target date fund.

Advisers and employers would welcome simpler 401(k) plans, particularly given impending rules that will require plans to disclose fees to plan participants, said Brian Ward, a Wells Fargo adviser based in Brentwood, Tennessee, who works with retirement plans.

"Everyone is trying to get it where it is simpler for employees to understand stuff," Ward said.

'FUNNY MISMATCH'

But making a plan simpler and doing away with choice are two separate things, and Ward is not sure how thrilled employees will be to see their plans get slashed -- even if it leaves them with a better option.

"Americans like choice," he said. "It's going to take a long time to get people to come around to this idea."

Another sticking point: It targets those who are opting out of being automatically enrolled into a fund, yet those are the people who will probably want to pick and choose their own funds, said Alicia Munnell, director of the Center for Retirement Research at Boston College.

"I really like the idea of reducing the number of options for people, but the problem is they are reducing the options for the people who think they want lots of options," she said. "It's a funny mismatch."

J.P. Morgan acknowledges that there will be some plan participants who will still want more choices. But often the participants who are opting out of the default still only choose two funds and never rebalance, Falcon said.

And if employers have plan participants who really want to be active investors and choose among many options, they can still have a self-directed brokerage account or a mutual fund supermarket to choose from, Falcon said.

Those plan participants, however will be paying more to access those funds through a self-directed brokerage account than if funds were available stand-alone in the plan, said Lori Lucas, defined contribution practice leader at Callan Associates.

For example, if participants wanted to invest in the PIMCO Real Return Fund , they would need $1 million to qualify for the 45 basis point institutional share class, available to 401(k) plans. Otherwise, the cheapest share class available would be 85 basis points, according to Morningstar Inc.

"The problem with self-directed brokerage accounts is that it can be a very expensive way of getting access to a fund," Lucas said.

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