Simplifying decision-making through features like automatic enrollment, auto-escalation and auto-default into a qualified deferral investment alternative (QDIA) is helping defined contribution plan participants close the retirement savings gap. But participants still need help achieving better diversification and overcoming risk aversion if they are to accumulate enough assets to meet their income replacement objectives in retirement.
Our recent study of more than 500 sponsors of DC plans with assets of $50 million and above and nearly 300 consultants and advisers, in partnership with Prudential, found that almost half of plan sponsors (47 percent) and more than half of consultants and advisers (55 percent) consider limiting investment options to avoid confusion and overlap to be a very effective means of mitigating participant risk. In interviews, plan sponsors also emphasized the advantages of creating a layered set of investment options that addresses the needs of employees with different levels of financial sophistication. And target date funds (TDFs) meet a clear need: 44 percent of plan sponsors said their participants almost always fail to adjust their investment allocation to reflect their age or years to retirement.
“The investment menu that plan sponsors select has a direct impact on participant behaviors,” says Amy Labanowski, partner and senior investment consultant at Mercer. “We know that most participants really don’t understand the difference between the different investment options. Research also shows that when confronted with too much choice, participants were often confused and make suboptimal investment decisions that can have a significant impact on their retirement readiness. I think that less is better in the case of menu design.”
Distiller Brown-Forman Corp., which sponsors corporate and union plans with a collective $448 million in assets as of July 2016, set out to create a set of investment options that meet the needs of a diverse workforce. “We use a blend of passive and managed funds and TDFs, and that’s been just a great way for us to cater to both the sophisticated investor who really can dive into the details and those that don’t want anything to do with all of that,” says Donna Wimbec, senior manager of global benefits compliance.
TDFs, especially when situated as the plan’s QDIA option, can play a critical role, says Labanowski. “Most participants don’t adjust their asset allocation as their circumstances and risk profile change as they approach retirement, so having a QDIA that automatically changes that mix and also automatically rebalances is key to making people ready for retirement,” she says.
Recognizing that it needed to make its investment lineup manageable for employees from the executive level to the factory floor, International Paper created a three-tiered structure. Bob Hunkeler, vice president of investments at the company, which sponsors a $5 billion 401(k) plan, explains, “In our tier one we have three balanced funds that range in risk from conservative to an aggressive-risk portfolio. In tier two, we offer 11 asset-class funds, so that participants who want to build their own portfolio can do so. Our tier three is a brokerage window for those participants who can’t find what they’re looking for in our first two tiers and maybe want to invest in individual stocks or bonds or some other fund, like a social fund, that we don’t offer in our main fund lineup.”
TDFs have become a central feature for many plan sponsors attempting to tackle disparities in workforce retirement saving behavior. In our survey, 86 percent said they either currently have TDFs in place or expect to offer them in the next year.
“Employee demographics are critical when evaluating TDFs,” says Clint Barker, senior vice president of retirement investment solutions at Prudential Investments. “The reason is that every plan is different. You need to consider what are the goals and objectives of the plan and what are the individual saving behaviors of that participant base. For example, is this a plan where employees tend to retire early or unexpectedly, and how does that influence what you do early in the glidepath? Do you want to give them more equity exposure earlier, to give them the opportunity to accumulate, since they don’t have the same number of earning years that other people may have? Do you want to have a glidepath that starts to derisk a little bit earlier, because these people are retiring early and you don’t want to subject them to a significant market downturn?”
Keeping expenses low is important too. But, says Wimbec, “it doesn’t have to be the lowest cost fund. It has to be a reasonable fund.”
At Brown-Forman, “we look at that at least annually, and in most cases – especially if we’re looking at replacing a fund or enhancing an offering somewhere – we’re looking at it more often than that. If it’s a managed account, you’re going to expect the fees to be a little bit higher than if it’s a passive or index fund – and that’s okay, as long as there’s a track record there to let you believe that’s a reasonable fee. We look at it with our investment committee.
“Replacing a fund also gets the scrutiny of the employee benefits committee, so there’s a two-tier process. We’ve hired an independent co-fiduciary in that spot. We use a 3(21) adviser to help us vet and help us make sure that we’re looking at the full universe. By the time it comes to the investment committee, we’re not looking at 40 funds, we’re looking at three, and distilling it from there.”
What’s generally considered to be the optimal investment menu continues to evolve as the focus of the industry conversation shifts from accumulation to decumulation. A 2014 Prudential Retirement study looked at outcomes based on the plan sponsor’s decision to utilize a default investment option that includes a guaranteed lifetime income solution. It found that participants with lifetime income options were more inclined to stay invested during periods of market turmoil, were better diversified and contributed more to their plan than those without.1
“I would say the first 20 or 30 years of the 401(k) world was all about accumulating assets for retirement,” says Hunkeler. “The next phase of the 401(k) plan is to address how participants take those assets that they’ve accumulated and transition to a period where they have to spend down that money.”
Demographics – notably, the aging of a large portion of the American workforce – are the central factor pushing plan sponsors in this new direction.
“There’s clearly been a shift, or more of a focus, on the decumulation side, ” says Michael Domingos, vice president of national corporate distribution and strategy at Prudential Retirement. “We can actually thank our friends in the baby boomer generation, because you do have this massive transference of wealth that’s coming to, and through, that point in retirement. We’re starting to see more of an increase in the concept of in-plan income.”
1 Prudential Retirement, Guaranteed Lifetime Income and the Importance of Plan Design, 2014.
ABOUT THE SURVEY
This study was developed by Institutional Investor, in partnership with Prudential, to identify the investment risks and behavioral challenges that need to be addressed throughout the retirement planning process and how plan sponsors, advisers and consultants are trying to overcome them.
To support this research, a survey was distributed to Institutional Investor’s audience of plan sponsors as well as advisers and consultants between January and February 2016. We received 511 completed survey responses from the plan sponsor audience and 295 completed survey responses from advisers and consultants.
Auto-enrollment: An automatic contribution arrangement that can be used as a feature in a retirement plan to allow employers to enroll employees in the company’s plan automatically upon meeting eligibility requirements.
Auto-escalation: A plan design option that allows a plan sponsor to increase participant deferrals annually by a set increment.
RISKS: Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.
The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the target date funds will become more conservative as the target date approaches by lessening the equity exposure and increasing the exposure in fixed income type investments. The principal value of an investment in a target date fund is not guaranteed at any time, including the target date. There is no guarantee that the fund will provide adequate retirement income. A target date fund should not be selected based solely on age or retirement date. Participants should carefully consider the investment objectives, risks, charges, and expenses of any fund before investing. Funds are not guaranteed investments, and the stated asset allocation may be subject to change. It is possible to lose money by investing in securities, including losses near and following retirement.
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