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Workplace savings plans and target date glide paths should be aligned to help meet retirement income goals
By Ruthann Pritchard Institutional Portfolio Manager, Fidelity Investments
Employers today face significant challenges in maintaining a competitive benefits program that includes helping employees achieve financial wellness in retirement. In an era where fewer employers offer pension plans, the reliance on defined contribution (DC) plans places the responsibility of saving and investing for retirement largely on the shoulders of employees.
This shift in responsibility for saving and investing for what could be 25—30 years in retirement has left many employees struggling and overwhelmed. Our research indicates that half of participants may not be invested appropriately for their age,1sand more than half of all employees are likely not on track to cover their basic lifestyle expenses—health care, food, and housing—in retirement.2
If employees are not on track to retire, employers may face increasing challenges in managing their workforce strategy.
Leading employers are focused on designing plans for retirement income replacement
An increasing number of employers are taking a pension-like approach and designing DC plans with a targeted retirement income replacement level in mind, often stated as a percentage of a worker’s final preretirement salary. Considering that a DC plan is the primary savings vehicle for most working Americans (six in 10),3 designing one that generates sufficient income during retirement is critical. This in turn can help align the other decisions participants make: how and how much to save, and how to invest. Progress is underway; the percentage of employers designing DC plans with a specific income replacement goal rose to 18% in 2015, up from 4% in 2013, and continues to increase.4
For employees, the combination of saving and investing is critical to achieving an appropriate level of income replacement. As highlighted in Exhibit 1, savings alone will only provide approximately 6.5 years of retirement income for an employee who could live 25—30 years or more in retirement. That’s a significant shortfall. Educating participants on the proper savings amounts and appropriate investments is crucial to having enough money to last throughout retirement and maintain a desired standard of living. (See exhibit 1)
Adopting certain plan design features can enhance participants’ ability and willingness to save and invest to help achieve better retirement outcomes. Automatic enrollment and annual contribution increase features can help boost participation and savings rates. In terms of investments, target date funds (TDFs) are now the default investment option for 85% of DC plans.5 They, along with other diversified investment options such as managed accounts, offer a single, professionally managed long-term investment that provides the appropriate asset allocation for participants. Considering that nearly eight in 10 participants indicate they do not have the will, skill, or time to manage their own investments, having do-it-for-me options like TDFs and managed accounts in an investment lineup is one of the most effective ways to help many participants invest appropriately.6
“With workplace saving plans being a key element to financial wellness in retirement, plan sponsors need to use plan design and investment choices that help take the guesswork out of decision making for participants,” says Katie Taylor, Director, Fidelity Workplace Investing. “Doing so can help them get on a better path to stronger retirement outcomes.”
Ensure the goals of a DC plan and TDF are aligned
As a default investment option, target date funds play a critical role in plan design. While they are well known for offering participants a way to help take the guesswork out of long-term investing, not all TDFs are created equal. Since DC plans are increasingly becoming participants’ primary source of retirement income, one important—and often overlooked—consideration is ensuring the TDFs underlying assumptions and glide path, or strategic asset allocation, are aligned with a DC plan’s income replacement goal.
As more plan sponsors design their DC plans targeting a specific income replacement goal for their participants, plan sponsors should ensure that the glide path of the TDFs in the plan is also aligned with that same goal. Is the TDF glide path built with a specific income replacement goal in mind? Most are not. Does the TDF glide path even have a stated goal? Many do not. With nearly two in five participants invested in target date funds—and that number increasing to three in five for Millennials7 —sponsors need to carefully evaluate what goal their TDF glide path and plan are designed to meet in the long run.
“If you were building a house, you would want a blueprint to help ensure that all elements of your home design were captured,” Taylor says. “That’s not that different from designing a DC plan. In both cases, your blueprint should detail the outcome you are looking for, and how to achieve it.”
No two TDF glide paths are alike
The glide path of a target date fund is an important determinant of an eventual retirement outcome, and glide paths vary significantly among investment providers (see exhibit #2). These differences can be based on assumptions from each TDF manager regarding participant behavior, such as savings rates and retirement age, and assumptions concerning participants’ tolerance for risk. In addition, some glide paths reach their final equity allocation at retirement, others 10 years past retirement, and still others 30 years past retirement.
As a result, each glide path can result in significantly different long-term outcomes for participants. For plan sponsors, selecting the appropriate TDF and corresponding glide path in a DC plan is very much an active decision, and requires the TDF provider to offer full transparency into the glide path methodology and assumptions. Employers can serve their employees well by evaluating and monitoring the glide path of the TDF in their DC plan to determine whether it was developed through rigorous research and analysis into the key drivers of the glide path
.
Make sure your DC plan can help drive better employee outcomes
Consider the following to help make sure plan design and investment choice are aligned:
- Review DC plan design and use behavioral data to identify where employees need help. Implementing plan design features and investment choices that promote strong participation, higher savings rates, and appropriate asset allocation will help get all employees on a path to better outcomes in retirement.
- Make sure the DC plan and the glide path of the TDF are designed with a similar income replacement goal. This alignment can help ensure a cohesive approach to retirement planning.
- Ensure plan design and TDF selection conversations happen together. Bring together key stakeholders from HR/Benefits and the Treasury/Investment Committee to discuss how plan design and TDF selection can help support the goals of the retirement program.
Contact Information:
workplace.fidelity.com
or advisor.fidelity.com
866.418.5173
Before investing in any mutual fund, please carefully consider the investment objectives, risks, charges, and expenses. For this and other information, call or write Fidelity for a free prospectus or, if available, a summary prospectus. Read it carefully before you invest.
Investing involves risk, including the risk of loss.
Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero.
*Chart is a hypothetical example based on a set of assumptions to illustrate the limits of income replacement that can be achieved through regular savings contributions alone (blue bars), and the need for an expected return on investment to achieve a desired level of income replacement over a longer retirement horizon (black bars). For the purposes of this chart, the following assumptions are presumed: investor starts contributing at age 25 through age 66, and receives annual salary increases equal to 1.5% over this period. Green bars represent an increasing percentage of investor contributions from 8% to 13% of salary from age 25 through age 66 (includes company matching funds). Blue bars represent the expected income replacement provided solely by the contribution amounts, equal to approximately 50% of one’s final preretirement salary through the early years of retirement. Black bars represent the expected income replacement needed through a target date portfolio’s investment returns, equal to approximately 50% of one’s final preretirement salary through age 93. A hypothetical internal rate of return (IRR) equal to approximately 4.5% in real terms is assumed (required investment return to have savings equal income replacement needs). This hypothetical illustration is not intended to predict or project the investment performance of any security or product. The IRR is a rate of return used in capital budgeting to measure and compare the profitability of investments. Past performance is no guarantee of future results. Your performance will vary, and you may have a gain or loss when you sell your shares. For many investors, these assets will be combined with other complementary sources of income (e.g., Social Security, defined benefit plan benefits, and personal savings). Source: Fidelity Investments.
- Based on Fidelity analysis of 21,200 corporate DC plans (including advisor-sold DC) and 13.5 million participants as of 6/30/2015. For “not age appropriately allocated” purposes, the participant’s current age and equity holdings are compared with an example table containing age-based equity holding percentages based on an equity glide path. The Fidelity Equity Glide Path is an example we use for this measure and is a range of equity allocations that may be generally appropriate for many investors saving for retirement and planning to retire around ages 65 to 67. It is designed to become more conservative as participants approach retirement and beyond. The glide path as of 12/31/13 begins with 90% equity holdings within a retirement portfolio at age 25 continuing down to 24% equity holdings at age 93. Equities are defined as domestic equity, international equity, company stock, and the equity option of blended investment options. The indicator for asset allocation is determined by being within 10% (+ or -) of the Fidelity Equity Glide Path and capped at 95% equity. We assume self-directed account balances (if any) are allocated 75% to equities, regardless of participant age, and so this indicator has limited applicability for those affected participants. For purposes of this metric, participants enrolled in a managed account are considered to be age appropriately allocated. Diversification and/or asset allocation do not ensure a profit or protect against loss.
- Fidelity Investments Retirement Savings Assessment, 2015.
- Participants in an Employment-Based Retirement Plan: Employee Benefit Research Institute, as of 2011.
- Fidelity Investments online surveys of 500+ employers; March 2013 and April 2015.
- Based on Fidelity analysis of 21,600 corporate DC plans (including advisor-sold DC) and 13.5 million participants as of Dec. 31, 2015.
- Fidelity’s Quick Questions/Investment Mix Web site, launched 8/6/13 to 1,851 targeted Fidelity Workplace Investing participants, data as of 1/17/14. Participants were asked simple questions to determine their level of engagement or skill with regards to managing their workplace savings. Participant answers to these questions helped categorize them in two categories: participants who manage their money on their own (22%) and participants who would like help managing their money (78%).
- Based on Fidelity analysis of 21,600 corporate DC plans (including advisor-sold DC) and 13.5 million participants as of Dec. 31, 2015.
Target date funds are designed for investors expecting to retire around the year indicated in each fund’s name. The funds are managed to gradually become more conservative over time as they approach the target date. The investment risk of each target date fund changes over time as the fund’s asset allocation changes. They are subject to the volatility of the financial markets, including that of equity and fixed income investments in the U.S. and abroad, and may be subject to risks associated with investing in high-yield, small-cap, and foreign securities. Principal invested is not guaranteed at any time, including at or after the funds’ target dates.
For plan sponsor and institutional use only.
Fidelity Institutional Services Company, Inc. 500 Salem Street, Smithfield, RI 02917
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917 © 2016 FMR LLC. All rights reserved.
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