Changes in MIT's 401(k) Plan

Peter A. Diamond and Andrew W. Lo

Among the many benefits that MIT faculty and staff receive, the Supplemental 401(k) Plan is one in which a large majority of the MIT community participate.

On a regular basis, the MIT Supplemental 401(k) Plan Oversight Committee reviews MIT’s 401(k) plan. The committee has just completed a thorough review of the plan investments – (an activity that is unrelated to the work of the Benefits Task Force). The review has led to a number of changes, which will provide participants with more passive investment choices (i.e., investments that are tracked by measuring against a broad market index such as the S&P 500), including “target date” funds, generally improved fees, and more user-friendly written and Web-based materials. In addition, these changes will reduce the complexities of investing for retirement without restricting those who desire greater flexibility.

Along with these changes, we thought it would be helpful for our faculty colleagues to have an explanation of the process and reasoning that led to these developments, supplementing the information being provided by MIT to all participants. What will not change is MIT’s record-keeper for the 401(k) Plan, Fidelity Management Trust Company. Fidelity will continue to provide administrative and recordkeeping services, including the enrollment of employees in the Plan, changes to investment and contribution elections, and the processing of beneficiary designations, loans, exchanges, and withdrawals.

The Supplemental 401(k) Plan Oversight Committee

The Supplemental 401(k) Plan Oversight Committee was established by the MIT Executive Committee to help MIT meet its fiduciary responsibilities under the Employee Retirement Income Security Act (ERISA). The committee is responsible for the selection and monitoring of investment options and consists of members appointed by the MIT President from among the senior officers, faculty, and staff of the Institute. [The current composition of the committee may be found at web.mit.edu/committees/president/Rosters/supp401k.pdf.] This oversight role is limited to the performance of the investments offered through the 401(k) Plan and does not include oversight of administrative operation or plan design.

The committee is chaired by MIT’s Executive Vice President and Treasurer. In 2007, MIT was very fortunate to have recruited Theresa M. Stone for this important role. An MIT Sloan alumna, Terry came to us with deep financial experience, having served as Chief Financial Officer of a Fortune 500 company, Vice Chair of the Board of the Federal Reserve Bank of Richmond, and Chair of the Board of the MIT Investment Management Company (MITIMCo), which is responsible for managing the Institute’s endowment, defined-benefit pension plan, and welfare benefit plan. Terry’s extensive financial expertise and leadership were invaluable as the 401(k) Oversight Committee conducted a major review of the investment options available to plan participants.

One of Terry’s first actions as Chair of the 401(k) Oversight Committee was to confer with the President and Provost about the composition of the committee, with the twin objectives of bolstering its investment expertise and maintaining broad representation of the entire MIT community. Based on Terry’s recommendations, two seasoned investment professionals were appointed to the committee: Marty Kelly and John Nagorniak. Marty is currently a managing director at MITIMCo responsible for marketable securities, and John was the Chief Investment Officer of State Street Bank and Trust Company before founding Franklin Portfolio Associates, and is currently a director of MITIMCo. Also, Institute Professors Peter Diamond (Economics) and Barbara Liskov (EECS), and Larry Candell (Lincoln Lab) were added to the committee, and Professor Andrew Lo (Sloan) was re-appointed. In the fall of 2007, the committee appointed a subcommittee consisting of Marty, John, and Andrew to engage in a more detailed analysis of the 401(k) plan’s investment options, and to report back to the full committee with specific recommendations and alternatives to consider. Given his expertise in the economics of Social Security and retirement issues, Peter also participated in several subcommittee meetings.

Actions of the MIT 401(k) Subcommittee

The subcommittee’s initial tasks were to interview and then recommend a professional investment consulting firm to assist the committee in discharging its duties, and to review the existing 401(k) plan’s choice of investment options and their presentation. From October 2007 through March 2008, the sub-committee interviewed several investment consultants, and based on its feedback, the committee chose unanimously to engage the services of Mercer Investment Consulting, Inc. Mercer brought considerable experience to the committee, having advised many corporate and educational retirement plans similar to MIT’s. The Mercer consultants assigned to MIT have been extremely helpful in every aspect of the committee’s deliberations, focusing particularly on regular reviews of the 401(k) plan’s investment performance, the selection of new investment options, and the operational aspects of moving assets from one manager to another.

From March 2008 through the end of the year, the subcommittee reviewed the investment design of the 401(k) plan and the specific investment choices available to plan participants. The subcommittee considered a variety of new managers, new investment products, the fee structures of existing funds, and the possible termination of underperforming managers.

This process was extensive, and was made all the more challenging by the financial crisis that started in 2007, and reached a crescendo during the fourth quarter of 2008 with the collapse of Lehman Brothers. During this time, the subcommittee met frequently to keep abreast of the impact that the developing financial crisis might have on the 401(k) plan, but the primary focus was on the broader agenda of improving the plan’s investment options and their presentation. Given a recent change in the law, the committee also had to decide how the 401(k) plan should invest the funds of participants who join the plan but do not select an investment option.

During the first half of 2009, the subcommittee formulated a proposal that included several new investment options including “target date” or “life-cycle” funds, the termination of consistently underperforming funds, the transfer of some of the plan’s assets to new managers, and a presentation of the investment options that placed more emphasis on passive index funds with lower fees. At the same time, the subcommittee was sensitive to ensuring that the 401(k) plan’s existing investment options would still be available as part of the new investment program (except in cases of consistent underperformance) so as to provide as much continuity as possible for those participants who were satisfied with their choices. These considerations were not trivial because prior to the creation of the current plan structure, MIT offered two investment options (an all-equity fund and a bond/stock fund), and to preserve continuity in moving from the legacy to the current structure, the Bond Oriented Balanced Fund and the Diversified Stock Fund were created, organized as commingled pools (i.e., combines the money of many investors who own a share of the pool) managed by MIT. These funds invest in a combination of underlying asset classes that were selected to approximate the underlying investment strategy of the legacy vehicles. Since many plan participants stayed with these options, they currently hold nearly 65% of the total funds invested in the plan. However, the choices of new participants have a very different pattern, with over 66% of new-participant assets being allocated to the “Investment Window,” which is a broad offering of mutual funds. Apart from the termination of a small number of underperforming funds, the new investment options will allow all participants to continue with their current choices if they wish, with some of the choices having new managers.

The proposed changes to the MIT 401(k) plan were approved by the Oversight Committee in the spring. In November, all plan participants were informed of the changes by e-mail and direct mail. The changes will go into effect at the start of 2010.
Before describing the changes in more detail, we would like to acknowledge the enormous contributions made by the other members of the Oversight Committee (Alison Alden, Larry Candell, Marty Kelly, Barbara Liskov, and John Nagorniak) and the MIT staff who support this committee (Gary Cahill, David Chused, Sophia Maniaci, and Jean Samuelson). None of these changes would have been possible without the dedicated efforts of these individuals over the past two years.

Our discussion of the 401(k) plan’s new investment structure begins with a summary of the changes in managers of existing funds since this is of direct interest to those invested in these funds. We then turn to the addition of new funds – including Vanguard Lifecycle Funds – to the investment array, and also describe a change in how the plan’s investment options are presented to participants. We conclude with a brief discussion of the new default choice for participants who do not choose an investment option when they join the plan.

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I. Changes in Managers

Bond Oriented Balanced Fund. This fund is a “commingled pool” currently combining seven separate funds managed by Pyramis, a division of Fidelity Investments. Two of the smaller Pyramis funds will be retained, which together represent 7% of the assets in this fund. The rest of the existing assets will be managed by PIMCO and Vanguard (approximately 40% of total assets to PIMCO and 53% to Vanguard). In terms of asset classes, the overall portfolio is not being changed, just the managers. With this change, we anticipate a reduction of expenses from .22 to an estimated .1655. With lower fees and a good track record of management, we think this is a better choice going forward. People invested in this fund do not need to do anything, but, of course, do retain the option of moving their investments to other funds.

Diversified Stock Fund. This commingled pool currently consists of six separate funds managed by Pyramis and Fidelity Investments. One of the smaller Pyramis funds will be retained and the rest of the assets will be managed by Vanguard. Again, part of the reason for a change is the anticipation of lower fees, with expenses estimated to decrease from .25 to .0759. People invested in this fund do not need to do anything, but, of course, do retain the option of moving their investments to other funds.
Some of the separate funds that make up these two commingled pools also are available as separate stand-alone investments. These separate investments will also experience these changes in management.

Fidelity Bond Pool. The existing underlying investments in this pool will now be managed by PIMCO (60% of the allocation) and Vanguard (40% of the allocation). The name will change to Core Bond Pool and expenses are estimated to decrease from .20 to .1898.
Fidelity US Equity Index Commingled Pool – Class 2. This fund will no longer be part of the larger commingled pools. By moving this fund out of the Bond Oriented Balanced Fund and the Diversified Stock Fund, the decrease in total assets under management will impact both the expenses, which will increase from .05 to .10, and the share class, which will change from Class 2 (institutional shares) to Class 1 (investor shares). You can access the Vanguard Institutional Index Fund in the Investment Window at an expense ratio of .05.

II. New Investment Options

Vanguard Target Retirement Trusts, Vanguard Index Funds. Some participants in the 401(k) plan want to actively manage their portfolios. Others are looking for investment options that can sensibly be held with limited attention to making changes. The new options and the new layout of options are designed to particularly help those who do not want to be actively managing their investments. When an individual invests in an “actively managed fund,” where the managers are choosing the investments and possibly changing them over time, the individual investor has to pay attention to how good a job the manager is doing. In contrast, a well-run index fund simply attempts to match the outcomes in some standard index of investments, such as the S&P 500 index. Given stochastic variation in the returns to any investment strategy, it is easier to tell whether an index is being adequately matched than whether, over time, an active manager is doing a good job. While not all passive fund managers do exactly the same in matching, there is not as large a concern about monitoring the performance of the manager. Thus “passive funds” are more convenient for those not planning on more monitoring of their investments. To aid those who want to follow the passive investment strategy, we have added a number of Vanguard Index Funds to the array of options. These Vanguard passively managed index funds generally carry lower expenses and fees than actively managed funds. While MIT’s 401(k) plan has always had some index funds among its investment options, the presentation of investment options available under the Plan has been redesigned to create greater visibility and easier access to these funds.

Recently, there has been growing interest in lifecycle funds. These are funds made up of a number of underlying asset classes that change the mix of different classes over time. The idea is to slowly move to a less risky portfolio which may be desired by some investors as they age. Among the 401(k) Plan’s new investment options is a family of Life Cycle Options that will provide participants with a diversified investment option with relatively low expenses (.14) – the Vanguard Target Retirement Trusts. “Life Cycle” or “Target Date” options are designed to automatically adjust the balance between stocks and bonds as participants approach the target date. These options may appeal to Plan participants who do not want to actively manage their investments and the stock/bond mix of their investments on their own. Again, as detailed below, we have placed them in an easy-to-find location in the presentation of investment options.

III. Presentation of Investment Options

The previous terminology that refers to Tiers I, II, III, IV is replaced by (1) Life Cycle Options, (2) Asset Classes, (3) Investment Window, and (4) Brokerage Link. The Asset Classes set of options includes the Bond Oriented Balanced Fund and the Diversified Stock Fund and a number of index funds covering different asset classes, both bonds and stocks. The presentation of the options in written material and on the web has been changed to make choosing easier. Some investment options have moved into Asset Classes or the Investment Window, but are otherwise unchanged.

IV. Change in Default Investment Option

Currently, when a participant does not select an investment for contributions, the contributions are placed in the Fidelity Retirement Money Market Portfolio. The 2006 Pension Protection Act (PPA) no longer permits use of a money market fund as a default investment, although it will still be available as an active choice. The new law permits the use of life cycle or target date funds as a default or automatic option for faculty who do not select an investment option. The new default will be the age-appropriate Vanguard Target Retirement Trust and will apply to new contributions. Thus the accumulations as of January 1, 2010 of participants who have been defaulted into the money market fund will remain in the money market fund, with new contributions placed in the lifecycle fund.

The committee will continue to provide oversight of MIT’s 401(k) Plan and periodically re-visit the investment lineup. We believe these current changes enhance the MIT plan and offer more choice for the MIT community.

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