Momentum

In the decade since the passage of the Pension Protection Act (PPA) in 2006, defined contribution (DC) plans have vastly improved—yet many people still appear to be unprepared for retirement. Industry experts agree that a wealth of opportunities exists for retirement plan advisers to work with sponsors and participants to improve savings rates through more aggressive plan design. In addition, with half of all Americans not covered by a workplace retirement savings plan, many in the industry believe retirement plans should be mandatory, and they continue to posit that income solutions will be the next big development for retirement plans.

“The Pension Protection Act was critically important and marked a momentous turning point of retirement savings in our country,” says Aimee DeCamillo, head of T. Rowe Price Retirement Plan Services in Baltimore. “PPA is a great example of the government, sponsors and the retirement planning industry working collectively to achieve the best retirement outcomes for the American worker.

“One of the greatest benefits was the safe harbor for the use of automatic enrollment and escalation,” she says. Although auto-enrollment had been used by some plans ahead of the PPA, many plan sponsors worried that the practice ran afoul of state withholding laws that prevented employers from withholding funds from a paycheck without the employee’s consent. The PPA provided a federal green light for plan sponsors to implement such a plan design.

Besides getting people participating in retirement plans, it also provided employers with a chance to improve employees’ asset allocation. “It opened the floodgates for target-date funds [TDFs] and set the stage for a high level of comfort for plan sponsors to use TDFs as the qualified default investment alternative [QDIA],” agrees Brian Catanella, senior retirement plan consultant with UBS Institutional Consulting Group in Philadelphia.

The Pension Protection Act also made it possible for plans to offer Roth 401(k) plans, notes Bill Peartree, a principal and director of the retirement services division at Barney & Barney in San Diego, California. “When [the Roth] was first available, the uptake was minimal,” Peartree says. “But we now see about 20% of sponsors offering it.”

Although the PPA did not focus on incentives to increase the number of employers offering retirement plans, it did boost participation through greater use of the automatic plan features, and influenced a move away from stable value or money market funds as the default investment, according to the 2006 and 2015 PLANSPONSOR Defined Contribution surveys.

What is noteworthy is that, between those years, the average participation rate increased from 70.1% to 77.1%; auto-enrollment increased from 17.1% to 41.1%—and across all plans, 61.3% of those with more than $100 million in assets now use such plan design; and auto-escalation rose from 5.8% to 16.5%. TDFs or asset-allocation funds were in use at 33.0% of plans in 2006 versus 61.7% in 2015.

But although auto-enrollment has grown participation rates at many plans, the deferral rates have remained quite low. In 2015, 3% was the most common deferral rate for plans with auto-enrollment—the case at 45.0% of plans— and participants’ average contribution rate was 6.4%.

This highlights the continued opportunity to evolve the plan designs endorsed by the PPA. “We need to increase automatic enrollment to a level that will get people to a savings threshold that will enable them to achieve a successful retirement,” says Tom Foster, national spokesperson for MassMutual Financial Group in Enfield, Connecticut. “Even if they are saving 5% to 6% of their salary, they will not be able to retire at age 65. Otherwise, it’s an exercise in futility.”

Part of the challenge in understanding how prepared—or not—people are stems from what Drew Carrington,  senior vice president  at Franklin Templeton Investments in San Mateo, California, calls a “snapshot” mentality.

For example, a recent survey of 1,000 participants by Natixis Global Asset Management found that Baby Boomers, ages 51 through 70, have an average retirement savings balance of $188,000, says Ed Farrington, head of retirement for Natixis in Boston. Couple this with his firm’s projection that they will need savings of $949,000, and it looks like they have only 20% of what they will need.

However, surveys such as this fail to consider “the fact that the individual may hold an individual retirement account [IRA], complemented by a pension from a previous employer, along with anticipated Social Security and potentially very significant home equity. And then there are the assets of the spouse or partner to consider, or even their children’s and parent’s assets,” Carrington says.

“This research begins to show us that there are still many people who need to save a lot more than they currently do for retirement,” he observes. “But we should keep in mind that the real retirement readiness of a given set of people is not a conclusion you can easily draw from compiling one standalone report,” which presents its own set of opportunities for advisers, sponsors, providers and policymakers to do and discuss.

Quantifying Plan Design

“I would like to see more focus on the default rates that are being used by employers when they automatically enroll employees,” says Christine Marks, president of Prudential Retirement in Hartford, Connecticut. “Three percent is the average in our book of business. This is not enough to replace your paycheck when you retire. You need to save at least 10% to 15%. We would like to see higher levels as the default along with a higher usage of escalation.”

A retirement plan adviser’s plan review typically focuses on participation and deferral rates, balances and fees, Foster says. “I call those table stakes.” Very few advisers take the time to analyze how many participants are projected to have a 75% income replacement ratio at age 65, he says. “We can show sponsors that if we implement automatic enrollment and escalation at higher levels, it will change the whole dynamic and reduce their economic liabilities as an employer of having a work force unable to retire at the appropriate age,” Foster says. “Quantifying the impact for the employer’s bottom line is extremely important.”

Besides the cost of keeping someone on the payroll who should be retired—who undoubtedly earns more than a younger employee—older employees cost an average of $8,500 a year in higher health care costs, says Joel Lieb, director of defined contribution on SEI’s institutional advisory team in Oaks, Pennsylvania. “It also means that if employees are working longer, employers risk losing the next wave of talent because [those people] can’t get promoted,” he says.

It is important for advisers to help sponsors understand the value of their retirement plan in the context of workplace management, agrees Ed Moslander, senior managing director of TIAA’s institutional relationship management organization in New York City. “Employers that can better prepare employees for retirement will be a more attractive employer,” Moslander says. “There’s a lot of competition for talent out there.” Advisers can help employers realize that “enhancing the retirement plan will help them recruit, retain and retire their employees.”

Meaningful Numbers

One way to open participants’ eyes to the tremendous importance of their 401(k) savings plan, and to inspire them to save more, is to show how their projected retirement savings will translate into monthly income, industry experts say.

“As far as the next development in plan design is concerned, the best thing would be to focus on the strategic objective of the retirement plan, which is the provision of income in retirement,” Moslander says. “The next level of plan design could achieve that by translating the account balance into an income figure on the statement, so that people don’t focus on the account balance but on what kind of a paycheck it could provide. Today, the implicit goal of retirement plans is to achieve the highest possible account balance by a particular date on a risk-adjusted basis. That’s not really a meaningful goal for participants.

“The next level for plan design would be an income replacement goal for their employees, achieved through contribution schemes, automatic enrollment, [automatic] escalation and potentially protecting that accumulation from different risks as people approach retirement,” he says.

That would be a far more profound number, Peartree agrees. “How many employees actually open their quarterly statement?” he asks. “Of those who [do], what percentage really know what they are looking at and how to translate the data? Utilizing technology such as simplified websites, mobile sites and mobile apps [to illustrate monthly income and how participants can improve that] will go a long way in helping people become more prepared for retirement. We need to take the guesswork out of the equation,” he says.

The Department of Labor in 2013 issued initial guidance on the potential disclosure of 401(k) account balances as monthly income streams, Foster notes. “We expect that it will be mandated to show participants how their balance translates into monthly retirement income,” he says.

Reducing Leakage

Natixis has found that 30% of participants have taken out a loan from their 401(k) and that another 30% take a lump-sum distribution when they change jobs, rather than rolling their savings over to their new employer, leaving the balance with their previous employer or opening an individual retirement account (IRA), Farrington says. “We need to educate folks so they don’t treat their retirement plan like an ATM card,” he says.

One way employers can help reduce leakage is by helping their employees pay back student loans, and this is a benefit that is beginning to pick up traction, Farrington says.

“Last year, there was $6 billion in leakage from 401(k) plans through loan defaults,” says Foster. “Employees still think of their 401(k) plan as more of a savings vehicle than a retirement vehicle,” which isn’t surprising, as 90% of plans have a loan provision. Retirement plan advisers can help sponsors look at their entire benefits package and make the case for offering an emergency cash savings option or disability insurance to discourage loans, Foster says.

Many industry experts continue to predict that the next big development in plan design will be the adoption of retirement income products.

“In the past six to eight years, we have begun to see some companies offering annuities or an annuity feature such as systematic withdrawals. In the next 10 years, we will begin to see more information on the annuitization of account balances,” says John Schembari, chairman of the employee benefits and executive compensation group at Kutak Rock LLP in Omaha, Nebraska.

Marks concurs: “Reframing DC plans as retirement income plans would do a lot to improve contribution rates and lay the groundwork to bring income options into DC plans. If you brought a guaranteed income option into a DC plan, it would look more like a DB plan, which provides peace of mind about living in retirement.”

While there is still work to be done, “when you dig deeper, what you find more often than not is that the retirement system is actually working quite well for many people, especially those who have had consistent access to plans and who have a good understanding of things like rollovers and how to avoid leakage—[i.e.,] people in plans with a lot of automation,” Carrington says. “Another way to say this is that the Pension Protection Act has been very successful and should be built upon, moving forward.”

Calls for Coverage for All

Of course, while all of the previously noted improvements could make meaningful differences, they fail to take into account that half of all Americans are not offered a workplace retirement plan in the first place. This is why major investment firms are calling for federal laws to make retirement plans mandatory and to include automatic enrollment at significant levels. According to executives at State Street Global Advisors (SSGA) and Empower Retirement, the time has come for another major piece of legislation like the Pension Protection Act (PPA).

A key attribute of the PPA, says Empower President Edmund Murphy III, in Boston, was the “real sense of collaboration between policymakers and the industry to help the 401(k) in its continuing evolution to better meet the needs of the work force. This is a model we should, and must, embrace once again.”

In June, SSGA met with key members of the Senate Finance and Health, Education, Labor & Pensions (HELP) committees to discuss drafting a new bill that will make retirement plans mandatory among all private-sector businesses with 100 or more employees. The bill would also have the plans automatically enroll participants at 6% or higher and combine that with annual auto-escalation of 2% until participants are saving at a rate of 12% a year or more, with the money routed into well-diversified, age-appropriate portfolios.

SSGA is also advocating to eliminate the requirement that open multiple employer plans (MEPs) be companies in the same industry, enabling far more small businesses to join them. In the coming weeks, SSGA will be meeting with the Senate committees’ counterparts in the House.

The fact that so many states are in the process of creating their own mandatory retirement laws indicates that politicians are ready to take on this challenge, believes Melissa Kahn, managing director of retirement policy at SSGA in Washington, D.C. “Response from policymakers has been positive, from both sides of the aisle,” she says.

The dual problems of longevity, which could increase even more in coming years, and today’s low-yield environment mean that people need to save 50% more than they did 10 years ago, says Fredrik Axsater, global head of defined contribution at SSGA , in San Francisco. “Time is not on our side,” he says. “We need to act now. America faces a $4.13 trillion retirement savings shortfall, according to EBRI [Employee Benefit Research Institute] data.”

Likewise, Empower is supporting legislation to facilitate MEPs, “starter” 401(k)s and “auto-IRAs,” at the federal level—in order to provide workplace savings to all working Americans. The firm is also calling for larger and refundable tax credits for small employers and savers, to increase the incentives to offer a plan and to save. Like SSGA, Empower also hopes to make auto-enrollment a plan requirement. In addition, the firm would like to encourage sponsors to provide lifetime distribution options.

In a positive step, in mid-June, the HELP Subcommittee on Primary Health and Retirement Security held a hearing on open MEPs, which the Insured Retirement Institute (IRA), American Benefits Council and Plan Sponsor Council of America applauded.

As Lynn Dudley, American Benefits Council senior vice president, global retirement and compensation policy, said, “Expanding the availability of multiple employer plans is one of the easiest and most effective things Congress can do to improve retirement plan participation. We are gratified and encouraged that these proposals have garnered the support of lawmakers.”

Art by Jasu Hu