They may exercise frenetically and eat responsibly, but even the heartiest elder members of the baby boom generation -- the 77 million Americans born between 1946 and 1964 -- are nearing the end of their working lives. In 2010, 2.6 million of them will turn 65; in 2020 another 3.8 million will arrive at that milestone.
Already, those baby boomers who are contemplating retiring in the next few years must reckon with the fact that, the 18 percent year-to-date gain in the Standard & Poor’s 500 index notwithstanding, the average 401(k) account lost about 9 percent of its value from the end of 1999 through the first half of this year.
“My clients, especially those who are close to age 65, are telling me, ‘I don’t want to lose any more money. I just can’t make any more mistakes.’ Those who were on track to retire at 65 are now looking at age 67 or maybe 68,” reports John Pulicare, a financial adviser with Ryan Beck & Co. in Livingston, New Jersey.
For the financial services firms that handle retirement assets, this combination of demographics and economics holds enormous implications, both good and bad. On the positive side, retiring baby boomers will be moving their 401(k)s into rollover IRAs, which are more profitable for providers to manage. Indeed, the rollover market, which also includes job-changers, has never been more hotly contested. Less favorably, baby boomers will be moving more of their assets out of equities and into fixed-income holdings, which are not as profitable to manage. Fees for stock funds average 100 basis points, compared with 20 basis points for bond funds.
“The rules that have governed our business are changing,” says James Phalen, CEO of CitiStreet, a joint venture between Citigroup and State Street Corp. that administers some $150 billion in defined contribution assets. “And they’ll continue to change in ways we can’t now predict.”
To accommodate the new reality, Wall Street firms have begun to introduce new products, mostly stock-bond hybrids, that seek to address specific retirement issues. Chief among these: the need for longer-living Americans to own enough equity to prevent the erosion of their capital.
Providers are especially concerned about the baby boomers because Generation X, the 46 million men and women born between 1965 and 1980, is relatively small. “It’s a double whammy,” says Luis Fleites, a consultant with Boston-based Cerulli Associates. “The baby boomers are beginning to retire, and Generation X will come nowhere close to replacing them in the workforce. This signals a significant change to the industry’s bottom line.”
Adds Peter Demmer, chairman of Paramus, New Jersey based Sterling Resources, a financial services consulting firm that tracks the retirement industry: “Are people really thinking about the seriously declining number of participants who will be in 401(k) plans, or are they just breathing a sigh of relief that the worst of the bear market is behind us? Whether it’s 2010 or 2012 when a mass of baby boomers retire, you know a moment of reckoning is coming.”
The industry is already coping with a sobering shift in the mix of 401(k) contributions from stocks to bonds. Of course, 401(k) equity holdings declined with the bear market, driving the total value of 401(k) assets from a peak of $1.8 trillion at year-end 1999 to $1.61 trillion as of June 30. According to Lincolnshire, Illinoisbased Hewitt Associates, at the peak of the market in March 2000, 77 percent of new contributions to 401(k) plans was invested in equities, including employer matches of company stock; by the end of September 2003, that ratio had fallen to 61 percent. Much of the change reflected increased conservatism among participants singed by the bear market, and some of the decline resulted from sales of company stock.
But the shift will be far more dramatic when aging baby boomers start changing their stock-bond portfolio balances. “This is what it is going to look like, only more so, as baby boomers move to more secure investments,” says Sheldon Gamzon, principal at PricewaterhouseCoopers’ human resources consulting group.
For several years plan providers have been battling to hold on to rollover assets, the 401(k) balances of retiring or job-changing plan participants. Cerulli estimates that these accounts totaled as much as $150 billion last year and might reach $450 billion a year by 2011.
Typically, only about 6 percent of these 401(k) balances is taken as cash or in a lump sum; another 25 percent is left in the plans, an option that many large companies now offer their departing employees. Job-switchers move about 9 percent of all rollover assets to their new company plans. The remaining 60 percent segues into rollover IRAs.
The challenge for the retirement industry: coaxing people to leave their assets with the same money manager that handled their former employer’s plan. To make this pitch, more than half of all plan sponsors offer special education services to people who are about to retire. “Forward-thinking providers are investing heavily in participant-focused strategies for the future, anticipating that many more participants will be retiring and that less growth will come from the plan level in the future,” says Sterling Resources’ Demmer.
Most of the advice is delivered face-to-face or over the phone, and that’s an expensive exercise. If baby boomers could be convinced to do more of their retirement planning via the Internet, the cost savings to the industry would be enormous. Help delivered over the phone runs about $7 a call, while an Internet-based exchange costs a provider only about 15 cents, according to CitiStreet’s Phalen.
But rollover accounts are considerably more profitable for providers to manage than 401(k)s. With IRAs, there are few expenses associated with administration or recordkeeping, no tax reporting requirements and no nondiscrimination testing. According to Demmer, money managers in 2002 earned approximately $3.5 billion in aftertax income managing $2.4 trillion in IRA assets, about half of which was rollover money. By contrast, they earned only about $184 million in aftertax income managing the $1.46 trillion in 401(k) assets.
The rollover game is never easy, however. In recent years plan providers have found that far too many rollover IRAs roll away to rival money managers, banks and insurers. And a lot of money is at stake. Says F. William McNabb, who oversees the institutional business at Vanguard Group: “When we lose a participant who is retiring, we lose an account with an average balance of about $150,000. A new-employee balance might be just $2,000.”
In early 2001 Cerulli estimated that plan providers held on to a mere 19 percent of rollover assets. One reason for that mediocre showing: Plan providers are restrained by regulations that restrict their ability to market directly to plan participants.
But the 401(k) industry has made considerable progress since then, reporting a 27 percent retention rate as of mid-2003, according to Cerulli. That improvement reflects industry efforts that include increased communication between the institutional and retail divisions of firms like Vanguard, a new cadre of hand-holding rollover specialists at many firms, aggressive contact with retiring participants and a trend among firms to extend the same investment options into retirement.
As a group, mutual fund firms, which collectively control about 50 percent of all 401(k) assets, are holding on to roughly 40 percent of moving assets. Not surprisingly, some of the best-known retail money managers boast retention rates above the norm. Vanguard reports a retention rate of 75 percent; Fidelity Investments and Charles Schwab & Co. both report retention rates of about 50 percent.
Whether baby boomers stay put in their current jobs, change employers or retire, most of them are making a gradual shift into more conservative investment vehicles. At year-end 2002, 401(k) participants in their 20s kept 51 percent of their 401(k) assets in equities, while participants in their 60s had only 30 percent of their defined contribution savings in equities, according to the Investment Company Institute.
But baby boomers may choose to invest relatively less of their retirement assets in fixed-income holdings than past generations did. That’s partly because they’re living longer: The average life expectancy for the 65-year-old American man is 81.3; for a woman, it’s 85. That’s up from 79.1 and 83.3, respectively, in 1980.
“There’s a risk of being underinvested in equities at this stage,” notes Jane Jamieson, who heads up marketing and product development for Fidelity’s employer services division.
Baby boomers may also decide to postpone their retirements. The recent bear market pummeled many stock retirement portfolios even as low interest rates generated paltry returns on their fixed-income assets. “I’ll work a few years longer, because I’m enjoying what I do now,” says 60-year-old John Hannigan, a civil engineer in Boston. “I’ve lost some portion of my money, but everybody’s lost something. It’s really a question of how comfortable you are with what’s left.”
Hannigan may have good company in his judicious approach to retirement. According to a study released by the AARP in late September, more older workers are planning to postpone their final retirement dates until their 70s or even their 80s. In a survey of 2,001 people between the ages of 50 and 70 -- one group whose members had not yet retired, and a second composed of “working retirees” -- the AARP found that 27 percent plan to work until they are in their 70s, and 18 percent aim to keep working in their 80s. Among the younger group, the expectations of keeping the nose to the grindstone are even more widespread: 34 percent intend to work into their 70s, and 23 percent plan to work into their 80s.
“For several decades, since the 1960s, people have been leaving the workforce earlier and earlier, a trend that is simply not sustainable,” notes Martha Farnsworth Riche, a former director of the U.S. Census Bureau who now consults on demographics issues. “Expectations hadn’t caught up with the reality of increasing life expectancy. But the AARP study indicates that people are beginning to understand that our retirements are not going to be like our parents’.”
To market to baby boomers who are either beginning or approaching retirement, financial services firms are offering new products, many of them stock-bond hybrids that provide some exposure to the stock market’s upside while providing some of the security of a fixed-income investment.
In March, for example, Merrill Lynch & Co. completed a $317 million offering of a new product known as a market recovery note. Pegged to the S&P 500 index and maturing in May 2004, these notes don’t pay interest but instead promise investors three times the market’s return up to a certain cap, with only a dollar-for-dollar risk on the downside.
“An investor might put one third of his capital in MRNs to keep exposure to the market and the remaining two thirds in bonds,” suggests Mitch Cox, who heads up Merrill’s structured-products department.
In mid-October, Vanguard launched an immediate annuity product developed with AIG Life Insurance Co. As with all annuities, the investor receives a guaranteed series of payments. He or she hands over a lump sum and in return gets this income over a fixed period; the rate is either fixed or variable, with the payout dependent on the performance of the underlying investments. The payout is immediate, because it begins as soon as the security is bought.
Immediate annuities typically carry an annual expense ratio of 200 basis points, but the average Vanguard immediate annuity expense ratio will come in at about 82 basis points -- higher if the underlying investments include actively managed funds, lower if they are strictly passive. Principal Financial Group is selling a similar hybrid product, known as an Income IRA, whose expense ratio runs about 145 basis points.
No doubt there will be much more innovation as the retirement services industry begins to address the drastic changes about to overtake its marketplace. The aging of the baby boomers presents both a huge challenge and a big opportunity.
