Since the Pension Protection Act was passed in 2006, more and more people have gained access to a retirement plan at work, but there’s still more that can be done to make sure those employees are ready to retire down the road.
The best way plan sponsors can help employees prepare for retirement is to offer a default investment option within their 401(k) or other defined contribution plan, according to Susan Czochara, managing director of retirement solutions for Northern Trust Asset Management.
In its annual report “The Path Forward,” Northern Trust Asset Management surveyed plan sponsors, plan participants and industry insiders about retirement and what is working to help employees save enough for retirement. What it found is that default options are very effective in getting people to not only save for retirement, but invest in options that meet their risk tolerance as they age. About seven in 10 participants who are defaulted into a target-date fund or other qualified default investment alternative will stay in the default, Czochara says, and out of those, 77% have invested 100% of their assets in that option.
“It comes down to balance: balancing market risk with longevity risk; making sure your default investment manages risk that is most important to you,” she says. In some cases, a person needs to take risk in order to accumulate enough to address longevity risk, while remaining aware of the volatility associated with market risk.
Most plans now offer a target-date fund option, which is an investment vehicle that reduces investment risk as a person ages. At their target retirement date, the investments either are at their lowest risk or still maintaining a steady decline in risk through retirement.
The big question is how target-date managers are managing those risks.
Northern Trust asked plan sponsors if they were concerned about inflation over the next five years. More than half said they were concerned about it over the past five years and 74% said they are concerned about it for the next five years.
Northern Trust’s advice is for plan sponsors to take a closer look at their menu and see how they are addressing inflation in that menu. Within the target-date framework, make sure there is a component that addresses inflation, Czochara says.
The industry is still facing challenges when it comes to transitioning from accumulation of assets to distribution of assets.
“For so long we were focused on the accumulation phase and less on how to consume those assets when we retire,” Czochara says. “Everyone is in agreement it is time to look more seriously and address the retirement income needs of participants.”
On the whole, participants have three needs for their retirement assets: safety, flexibility and efficiency, she says.
She encourages plan sponsors to design an investment menu with options that help participants address all of those. If employees are concerned about outliving their retirement assets, an annuity option could address that need. If employees are looking for flexibility, there are systematic withdrawal options that could achieve that goal. For efficiency, remaining in a target-date fund that continues to evolve over time might be the best option.
Andrew McIlhenny, executive vice president of Firstrust Financial Resources, says that there are all kinds of annuities available in the market today, but over time they have gotten a bad rap.
“There are a lot of good annuities out there that have been thrown into a basket of negativity that probably shouldn’t be,” he says. “I do like annuity options within a plan. Guaranteed income streams can be built out of retirement plan assets. Hopefully we will get to a point where they can be a choice, and participants can have a choice within the plan to select from different providers and annuity income stream options.”
McIlhenny says that his company offers annuity options on a number of its platforms but participant uptake has “very minimal.”
“It is startlingly low, but I think it is probably because the options available on the platforms are cumbersome and not easily understood for participants so they get overwhelmed,” he says.
Czochara agrees that there is a lot of negative information out there about annuities.
“It is almost like they need a different name. They need a rebranding,” she says. “I think there is such a stigma associated with the annuity term that scares some participants when in fact it is what’s going to provide them with the safest form of income for them.”
The first step is to get to the point where companies are offering participants decumulation options, Czochara says. Many plan sponsors question whether their job is just to get people to save for retirement or to help them get beyond retirement.
Northern Trust also found that plan designs that include automatic features have been very successful in getting employees to participate in their workplace defined contribution plans. The problem is that many companies are not implementing these features in a helpful way, Czochara says.
Many auto-enroll employees at a very low 3% or less deferral rate with no automatic escalation feature. Many times, employees will just leave that allocation alone, never revisiting it, so it is crucial that employers consider making the initial deferral higher, say 6%, and pairing it with an auto escalation feature that will continue to bump up a person’s contribution by 1% a year until they reach 10% or more of pay, including the employer match.
“Auto features work well if implemented thoughtfully,” Czochara says.
In its survey, Northern Trust found that the majority of plan participants were willing to accept auto escalation if the employer implemented it. Employers, on the other hand, were worried about implementing automatic features for fear employees would think they were being too paternalistic.9
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