Trendspotting

Alternatives in TDFs
The aim is diversification

As plan sponsors search for ways to find value and diversify asset classes in their defined contribution (DC) plans, many have considered offering alternative assets as an option. These assets provide the benefits of diversification and low correlation to traditional asset class performance. However, concerns about the scalability, liquidity and valuation needs of defined contribution plans have inhibited the use of such assets as a viable investment option.

In “Adding Alternatives to DC Plans,” Northern Trust explores the operational and plan structure options available to plan sponsors that wish to include alternative assets in their plans.

Three possible solutions—target-date funds (TDFs), a combination of defined benefit (DB) and defined contribution assets into a unitized structure, and indexation—are explored in the paper.

Target-date funds are one of the best ways to incorporate alternative asset classes into 401(k)s and other such plans, says the Defined Contribution Institutional Investment Association (DCIIA), which also recommends using a bundled alternative assets portfolio or adding alternatives on a standalone or index basis.

White labeling, or moving away from brand-name mutual funds to more generically named funds customized to a specific defined contribution plan, is a path gaining traction. It can increase the plan’s flexibility, help it cut costs, streamline investment menus and reduce participant confusion over investment choices. This approach can also let plans use their existing plan managers and potentially achieve higher alpha.

Alternative assets are increasingly held inside target-date maturity funds, including white labels. Commingled DB/DC structures are increasingly used to house more alternative investments—real estate investment trusts (REITs), currencies and commodities wrapped into investment vehicles such as hedge funds, private equity, mutual funds, exchange-traded funds (ETFs) or separate accounts. Through structuring, the alternatives can also be excluded from the cash flow of the target-date fund—necessary because alternatives do not accommodate daily liquidity.

According to Tom Lauer, defined contribution asset servicing consultant at Northern Trust in Chicago, a number of clients want to put alternatives into TDFs for their defined contribution plans but, for various reasons, cannot get it done. Some solutions can allow these clients to work around perceived challenges.

Clients ask about the best methods for dealing with liquidity and valuation challenges, as interest in including alternatives has increased, Lauer says. “We tell our clients that there are ways to structure their plans that allow them to take advantage of alternative assets,” he says. “Some clients find it appropriate to integrate defined benefit and defined contribution plan assets in order to leverage scale and provide participants with access to alternatives.” —Jill Cornfield

Keeping it Steady
Sponsors see the attractiveness of stable value

Art by Eron HareThe vast majority (82%) of defined contribution (DC) plan sponsors that are familiar with the U.S. Securities and Exchange Commission (SEC)’s amendments to the rules governing money market funds (MMFs) feel that stable value makes a more attractive capital preservation option for plan participants. These are the findings of the MetLife 2015 Stable Value Study.

Additionally, most stable value fund providers and advisers—that were interviewed for the study and are familiar with MMF reforms—predict that the use of money market funds in defined contribution plans will decline over the next few years.

The leading reasons plan sponsors give for offering stable value are to provide a capital preservation option (65%), guaranteed rate of return (50%), and better returns compared with money market and other capital preservation options (49%). Among plans with more than 100 participants that added stable value in the past two years, 77% offer it because it delivers better returns than money market and other capital preservation options, up significantly from 38% in the MetLife 2013 Stable Value Study.

However, despite recognizing stable value as a more attractive capital preservation option, the study found there is a need for better communication about the funds’ strong performance—only 17% of plan sponsors and 23% of plan advisers realize that stable value returns have exceeded inflation over the past 25 years.

“Stable value has a 40-year track record of performing exceptionally well—no matter what the market conditions,” says Thomas Schuster, vice president and head of stable value and investment products with MetLife in New York City. “Educating plan sponsors and participants about the advantages of stable value will not only help move plan assets to stable value, but will also help retain assets in qualified retirement plans, offering participants enhanced retirement income security,” he says.

When it comes to stable value’s performance against money market funds, the study found that nearly half of sponsors (47%) are unaware that stable value returns have outperformed money market returns: 22% believe that stable value and money market returns have been about equal, and 21% do not know how the returns compare. Additionally, 4% believe that money market funds have performed better than stable value over this time period.

“Two rounds of reforms have reduced money market’s expected returns and made them less customer-friendly,” says Warren Howe, national director for stable value markets, MetLife, also in New York. “The reforms have also highlighted the fact that money market funds are designed for general retail use. In contrast, stable value funds, which are designed specifically for employer-sponsored plans, are uniquely structured to maximize returns while preserving principal.”

Besides these reforms, recent litigation will also likely affect plan sponsors’ decisions about which capital preservation products to make available to defined contribution plan participants, MetLife says. So far, six months after a $62 million class-action settlement, followed by the recent U.S. Supreme Court ruling in Tibble v. Edison, 20% of plan sponsors are considering alternatives to money market funds, according to the study. Schuster believes others may follow suit. “Plans that continue to offer money market and not stable value are potentially exposing themselves to enhanced litigation risk,” he says.

MetLife engaged Greenwald & Associates and Asset International, Inc., publisher of PLANSPONSOR and PLANADVISER magazines, to perform three separate studies—an online survey of 205 plan sponsors conducted in June 2015, as well as in-depth phone interviews with 20 stable value fund providers, and with nine advisers, from July 14 through August 28. —PA

Retiring at 75
Millennials could face late retirement

The class of 2015 faces a retirement age as late as 75—two years later than what the Class of 2013 could expect—because of increasing student loan debt, rising rents and Millennials’ approach to money management, according to analysis by NerdWallet.

Compared with the current average retirement age of 62, that is an extra 13 years spent working, for today’s college graduates. And, with an average life expectancy of 84, they will spend only nine years in retirement.

Two major factors are dragging on the ability of Millennials to save early on, which will force them to work longer. The first is increasing student loan debt, which now averages $35,051, up more than $5,500 from 2012, when it was $29,400. This translates into larger monthly student loan payments, diverting money that could otherwise go into retirement accounts. The difference in monthly payment is more than $60—i.e., $353 today vs. $289 in 2012.

“The student loan crisis is not only affecting new graduates’ immediate financial situation, it’s making their retirement prospects dwindle,” says Kyle Ramsay, investing manager at NerdWallet in San Francisco. “Based on our findings, higher loan payments have the potential to reduce nest eggs by 32%. That’s nearly $700,000 in this scenario.”

Ramsay cites the powerful force of compound interest as an element in building a nest egg. A 23-year-old who invests $10,000 at a 6% return could see a sum that is twice that amount by the time he is 35 and 20 times that by the time he is 75, he says.

“Graduates are being forced to shell out more money,” says Ramsay, and that means less going into savings. “This puts them in a tough position because not only are they unable to save early, but they’re losing out on earning interest on those savings.” A delay in homeownership also slows Millennials’ ability to build assets, with buyers now purchasing a first home at the median age of 33.

When Millennials do find the money to save, they are all too likely to keep their money on the sidelines. According to research from State Street, Millennials have an average of 40% of their saved money in cash, such as checking and savings accounts, and term deposits such as CDs. Missing out on investment returns—even the semi-conservative 6% annual return used in NerdWallet’s analysis—for that portion of their portfolio could cost more than $300,000 of future savings. —Jill Cornfield

MISSING THE MARK: Although 59% of Americans set a goal to save for retirement in 2015, only 31% did so, according to a new survey of 1,000 people with investable assets between $50,000 and $250,000, conducted by Bank of America and Merrill Edge.

Living the Good Life
Creature comforts derail retirement

Art by Lauren TamakiThe No. 1 reason Generation Xers and Baby Boomers fail to save more for retirement is an unwillingness to sacrifice their current quality of life, a choice cited by 34% of Gen Xers and 29% of Boomers, Charles Schwab found in a survey of 1,000 investors.

For Gen X, other demands that stunt their nest egg’s growth, in order of importance, are: saving for their children’s education (cited by 32%), needing money to pay basic monthly bills (28%), and still having to pay down student loans (14%). Boomers’ additional obstacles include: basic monthly bills (20%), a child’s education (10%), and student loans (6%).

Only 58% of Gen Xers know how much they will need for a comfortable retirement, and just 53% think they are saving enough to be able to retire when they choose to. This group is also the most likely to have taken a loan from their 401(k), with 31% having done so, compared with 13% of Millennials and 29% of Boomers.

“Borrowing from a 401(k) is like stealing from your future self,” says Catherine Golladay, vice president of participant services and administration at Schwab Retirement Plan Services in Cleveland. “A 401(k) loan can severely derail your savings plan and comes with steep tax penalties if you leave your job and can’t repay the loan, so it should be viewed as a last resort for everyone, regardless of age.”

Among Boomers, only 63% think they are saving enough to retire when they choose to; 65% think they will be comfortably retired in 15 years; and 22% think they will retire at a lower standard of living than what they would like. They are also more concerned about being healthy enough to enjoy retirement (61%) than having enough money to enjoy it (39%). However, on the bright side, 40% of Boomers are getting investment advice, compared with 7% of Millennials and 10% of Gen Xers. —Lee Barney

On ‘Auto’ Pilot
Experts foresee auto-enrollment taking hold

Ninety-five percent of retirement plan experts foresee 55% of plan sponsors automatically enrolling participants by 2019, according to Transamerica Retirement Solutions’ “Prescience 2019: Expert Opinions of the Future of Retirement Plans.” The report is based on the opinions of 62 experts, including Quinn Keeler, senior vice president, research and surveys, at Asset International in Stamford, Connecticut. 

 Seventy-four percent say that 45% of sponsors will default participants into their plans at 6% or higher; 79% believe nearly all retirement plan providers will send participants alerts about their state of retirement readiness; and 92% anticipate that providers will show participants whether they are on course to reach a funded retirement. 

 “While plan sponsors are still focused on increasing participation in retirement plans by their employees, they are also looking for ways to increase contribution rates participants need to achieve a successful retirement,” says Wendy Daniels, senior vice president of retirement marketing for Transamerica Retirement Solutions in Harrison, New York. “[Additionally,] an expanded and more sophisticated use of mobile applications [apps] will help overcome communications challenges brought on by an increasingly dispersed workplace and also help participants manage their retirement funds more effectively.” 

 Eighty-six percent of the experts think the number of home-based and mobile employees will rise 20% to 18 million by 2019, prompting 86% of the experts to believe nearly all retirement plan providers will offer apps and increased functionality for mobile devices. 

 The experts also foresee that total retirement assets will grow 40% to  

 $35 trillion over the next four years, and that 75% of small employers—i.e., those with 50 to 100 employees—will offer retirement plans. 

 As the report says, “Plan sponsors are increasingly going beyond the call of duty when evaluating their advisers and [their] service providers—switching from satisfactory service to plan-level success metrics now and participant-level retirement outcomes by 2019. Prompted by plan-level retirement readiness reports, by 2019 more than half of plan sponsors will have taken meaningful action to alter plan design in order to improve the retirement readiness of participants. But perhaps the most impactful action is automatically enrolling participants into the plan at higher contribution rates and automatic deferral increases.” —Lee Barney

In for the Long Haul
Compound interest can save Millennial retirements

It’s a question many people ask themselves during a working career: What would it take for a middle-class person to save a million dollars?

Prudential suggests one answer in a recently released white paper, “Why Young Investors Should Start Saving Early and Invest in Equities.” As the title indicates, the key for an average-wage-earner to one day join the millionaires’ club is investing in a tax-advantaged retirement plan early, consistently, and with sufficient levels of contributions and risk-taking.

It is an increasingly relevant question, Prudential says, because workers entering the labor force today should expect to need just about $1 million to fund their retirement years. A couple’s health care costs alone will approach $300,000, and that is just at the median.

Prudential’s research finds Millennials, all in all, have made a decent start of saving for retirement. Just as many or more people in this generation are already saving as previous generations, for example.

Less encouraging is that Millennials face a fundamentally different investing environment than their parents or grandparents  did, one characterized by weaker global growth and less opportunity to find dependable sources of investing income.

“Some young investors believe if they begin saving as much as they can, they’ll have plenty of money when it comes time to retire,” Prudential continues. “That’s a good start, but many of today’s youngest investors are at risk of not having enough assets at retirement because they are not starting early enough or are too conservative with their investments.”

Matching other industry research, Prudential finds there are many Millennials—about 40% of those in the work force—who either are unable or choose not to save for retirement. The research points to student loans as one major hindrance across the generation, which has also been hit with reduced incomes due to lackluster employment and economic conditions, post-crisis.

Another issue is that many Millennials who have started saving may not be making the wisest investment choices. Prudential says younger investors “might learn a thing or two from retirees who advise to start saving early and put away more. Nearly 20% of retirees surveyed also wished they had invested more aggressively.”—John Manganaro

Under a Watchful Eye
Advisers boost retirement planning efforts

Pre-retirees who work with an adviser are more likely to have done the necessary retirement planning that would lead to more realistic confidence in their retirement security, according to the LIMRA Secure Retirement Institute.

Study results published in the institute’s new “2015 Retirement Income Reference Book” reveal that two-thirds (67%) of those who work with an adviser have determined what their income in retirement will be, compared with 46% of those who do not work with one. Sixty-three percent of respondents with an adviser have determined what their expenses will be, while only 39% of those without one have done so.

Those who work with an adviser are more apt to have calculated what their Social Security benefit will be at different ages than those without an adviser (80% vs. 57%). The same is true for determining health care  costs in retirement (57% vs. 33%) and estimating how long their savings will last (50% vs. 27%).

In addition, pre-retirees who work with an adviser are more likely to feel confident than those who do not (79% vs. 50%). Forty percent have devised a specific plan for generating retirement income from savings, compared with only 22% of those without an adviser.

While some planning is better than none, a specific plan enables pre-retirees to feel confident about retirement because of real information and preparation instead of ad hoc strategies and belt-tightening, LIMRA says.      

More than 1.5 million people will retire every year from now until 2025, LIMRA says.

Overall, the research found that just over half of pre-retirees (ages 50 to 75 with at least $100,000 in household investable assets) are confident in their retirement security based on their self-assessed ability to manage finances (62%) and the expectation of living modestly in retirement (59%). However, study results reveal that only 20% of all respondents actually have a formal retirement plan, and less than 40% have done basic planning activities, such as calculating what their assets, income and expenses will be.

Institute research shows that only one in four retirees express major concern about longevity risk, even though half of 65-year-olds will live into their late 80s. And less than half say they are concerned about the risk of having to provide for long-term care expenses and costs associated with health care outside of what Medicare covers.

Institute researchers point out that real-world planning for retirement is critical to achieve that goal.

—Jill Cornfield



CASHING IT IN: Cash-outs and loan defaults were responsible for $81 billion in lost retirement assets in 2014, according to a report from Cerulli Associates, “Evolution of the Retirement Investor 2015: Insights Into Investor Segmentation and the Retirement Income Landscape.”