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Annuities Seen as the Better Choice
An analysis of systematic withdrawals vs. annuities 

Art by Michela ButtignolAn academic analysis by Mark Warshawsky, a visiting scholar at the Mercatus Center at George Mason University, in Arlington, Virginia, examines two commonly proposed solutions for controlling outflows from defined contribution (DC) plans—the purchase of immediate lifetime income annuities and the well-known 4% rule.

As explained by Warshawsky, far more workers now rely on 401(k)-style retirement plans than in years past. He suggests this trend will continue as more employers move toward DC-style retirement benefits.

“While we know how to pay into this new generation of retirement plans, we have not yet determined how best to structure the payouts,” Warshawsky writes. “Now that more workers with 401(k)s or individual retirement accounts [IRAs] are retiring, it’s time to address this question quickly and decisively to help retirees get orderly, lifelong payments.”

Relatively few plan sponsors and advisers today coach their participants to strictly follow the 4% rule, by which participants spend down 4% of their retirement assets per year—increasing the percentage over time to address inflation. But many advisers and sponsors put their own spin on controlled withdrawal programs, which build off a similar philosophy; the main benefit is that participants maintain control over their assets, he says.

“There are, theoretically, more complex strategies and products on both sides of this debate, but—both practically and for policy purposes—an empirical investigation into the basic choices is an excellent starting point for discussion,” he notes.

Running his analysis, Warshawsky finds that lifetime annuities “are preferable to withdrawals because their income flows are generally higher and present less risk.” Even for those who do not wish to annuitize their entire plan balance, he argues that strong positive benefits accrue from purchasing an immediate life annuity with at least part of one’s 401(k) or IRA balance.

Many of his supporting reasons will be familiar to retirement industry practitioners—first and foremost is that individuals tend to underestimate their own lifespan, leaving them at a significant risk of spending down assets too quickly in retirement. While the risk of individuals dying before breaking even on an annuity purchase is real, they do not run the risk of running out of money entirely.

Warshawsky says the data is pretty clear that, whatever the withdrawal structure, participants need to save a substantial amount to have a successful retirement. Both the value of annuity income streams and structured direct withdrawals will be diminished over time by inflation. This is another reason he believes annuities are preferable—they are subject to inflation risk but not market risk.

Warshawsky “discourages government policymakers from taking a strong stance and harming those who might be better served by setting up an effective direct withdrawal.”
—John Manganaro

$24b in Matches Unclaimed
… but when participants receive advice, they increase savings

Americans fail to receive billions in company matches, according to research from Financial Engines. The company’s new report “Missing Out: How much employer 401(k) matching contributions do employees leave on the table?” estimates that Americans walk away from $24 billion in 401(k) company matches each year.

Why do so many American retirement plan participants pass up the chance to potentially receive thousands of additional dollars annually in the form of employer 401(k) matching contributions? The researchers examined the saving records of 4.4 million retirement plan participants at 553 companies and found that one in four employees (25%) misses out on the full company 401(k) match by not saving enough. The typical participant failing to receive the full match loses out on $1,336 of potential free money each year, which adds up to an extra 2.4% of annual income not received. With compounding, the amount could be as much as $42,855 over 20 years.

Turning to its own client base of large employers that provide advice services, Financial Engines pulled data on participants who are eligible to contribute into their company’s 401(k) plans, says Greg Stein, director of financial technology in Sunnyvale, California. The company filtered down further to those participants for whom it has salary data, then those in a plan with a match, to arrive at its survey number.

Most employers (92%) that offer a 401(k) plan also match their employees’ contributions, according to data from Aon Hewitt. The most common scenario is $1 for every dollar the employee contributes, up to 6% of annual salary.

“Plan sponsors and plan advisers have a number of levers at their disposal to impact these savings rates, and hopefully these numbers will help them think about how they might approach the topic with their participants,” says Financial Engines spokesman Mike Jurs, also in Sunnyvale.

Receiving services from an adviser means participants are more likely to get the match, no matter the participant’s age or income level, according to Financial Engines’ report. Age and income do have some impact on whether or not the participant will walk away from the match, Stein says. “The larger your income and the greater your age, the less likely you were to miss out on the full employer match,” he says. For those between ages 35 and 45, the effect flattens a bit, probably because they are buying a first house, paying for child care and starting to put money away for their children’s education.

The report found that across all ages and income levels, participants who used advisory services missed out less on their employer match compared with those not receiving this help—15% vs. 26%. Among employees earning less than $40,000 who used workplace advisory services, 25% missed out on part of their employer match, compared with 44% of those who did not use advice services.

According to Stein, the numbers give plan sponsors a clear assignment and can be used in communications targeted at early middle-aged savers: “If you’re not getting the full match, take a second look at your contribution level.” Also, he says, sponsors can message younger employees, who have time on their side, reminding them of the big benefit they gain in getting started early; that way, they can accumulate more savings over time and take advantage of the compounded growth in those savings.

“Many people may feel they can’t afford to save more,” Stein says, adding that he hopes the report will help people realize they can’t afford not to save, even if they were unaware of the benefit. If saving is a challenge, there are ways to save more—enrolling in automatic escalation or contributing the amount of a raise, for example—without feeling the loss as much.

Additionally, the report can raise awareness of the benefits of meeting with an adviser.

Source: Financial Engines

—Jill Cornfield

Viewing Retirement as Passé
Many Boomers, Gen Xers feel giving up work is out of reach

Source: Allianz Life, “Generations Apart “ study. The study was fielded by Larson Research and Strategy Consulting and was conducted online in November 2014 with a nationwide sample of 2,000 U.S. adults, ages 35 to 67, who have a minimum household income of $30,000. Respondents were split evenly between men and women and between Baby Boomers (ages 49 through 67) and Gen Xers (35 through 48).  

Americans Unsure About Financial Goals

Few Participants Have Distribution Plans

Workers Need to Be More Engaged
Taking that step could improve their outcomes

Art by Jing WeiAn analysis from Aon Hewitt suggests an opportunity exists by which retirement plan participants can become more proactively involved with their accounts and improve long-term savings. Only 15% of defined contribution (DC) retirement plan participants rebalanced their portfolios in 2014—making it one of the lowest trading years on record, according to Aon Hewitt’s analysis of 138 defined contribution plans, representing 3.5 million eligible workers.

Even when eliminating the participants who are fully invested in target-date funds (TDFs) or other pre-mixed portfolio options—which do not require rebalancing—only 19% rebalanced their portfolios. Aon Hewitt also found that, on average, participants were invested in just 3.6 different funds, down from 3.7 in 2013 and 3.9 in 2012.

Rob Austin, director of retirement research at Aon Hewitt, in Charlotte, North Carolina, says that even if participants have all of their money invested in a target-date fund or managed account, they should periodically consider whether that is still the right investment for them.

If a participant has atypical plans—such as wanting to retire early or late, or to prepare for children’s college costs—a change to the TDF and/or any other investments may be warranted. “At least annually, look at whether your investments meet your objectives,” he says.

As for participants in funds other than so-called “set it and forget it” investments, Austin says, it is easy to look at a quarterly statement and, if the overall balance has gone up by a pretty good margin, believe no action is really needed. Behind the scenes, though, different types of equity investments have different returns, as do different types of bonds. “Wherever [participants] have their assets, the allocation has changed. They should at least sign up for automatic rebalancing, if available, to put their allocations back to the same percentage originally chosen,” he says.

Austin notes that this also conforms with the adage of selling high and buying low—for example, if large-cap equity had very high returns and bonds underperformed, rebalancing will sell large-cap equities and buy bonds.

Aon Hewitt offers other recommendations that sponsors can use to help defined contribution plan participants make the most of their investments:

Offer access to “help” tools. A 2014 analysis from Aon Hewitt and Financial Engines showed that participants who take advantage of help tools—in the form of managed accounts, online advice and TDFs—fare better than those who go it alone. Providing these resources gives participants the benefit of professional management by which to optimize their returns.

Simplify the fund lineup. Offering participants multi-manager, white-label or objective-based funds can make the investment process less complex while providing better diversification. Additionally, these institutional funds may reduce fees for participants and potentially provide better returns, ultimately improving their long-term savings.

Consider lifetime income options. Defined contribution plans have become the primary retirement vehicle for millions of Americans, but few of these plans provide a way for participants to manage their money during retirement. Lifetime income options can help ensure that retirees do not outlive their savings.
—Rebecca Moore

Conservative Options Needed
Lower-risk funds remain an important part of the retirement plan menu 

Advisers should continue to advocate for conservative investment options in their plan sponsor clients’ defined contribution (DC) retirement plans, experts say. While use of a conservative fund as a default investment has grown less prevalent under the Pension Protection Act of 2006 (PPA)—replaced in many plans by far more aggressive target-date funds (TDFs) or asset-allocation portfolios—this does not mean conservative options should be dropped entirely.

“We believe conservative options have a place in retirement plans—even as the QDIA [qualified default investment alternative]—for a number of reasons, the most important being that participants struggle with seeing negative returns,” says Tim McCabe, senior vice president and national sales director, retirement, at Stadion Money Management in Watkinsville, Georgia. If a plan uses a conservative, balanced fund as the QDIA, participants stay invested, McCabe says.

Following the market crash of 2008, “many participants converted to cash and didn’t get back into the market until 2012—missing the market run up,” he says.

Another consideration advisers should keep in mind, McCabe says, is that “with six-plus years of significant market gains, now is a really good time to have conservative options in a plan.” He is not predicting a market crash, but he warns that the Federal Reserve has indicated it will raise interest rates either as early as this summer or as late as the fall to reflect the market recovery, which could affect the value and volatility of some bond funds. “In a rising interest-rate environment, bond funds can lose their value as quickly as equity funds,” he says.

Conservative options do have a place in retirement plans, agrees Winfield Evens, director of outsourcing investment strategy with Aon Hewitt in Chicago. “You want enough options in the lineup so that participants can diversify their risk,” he says. Conservative funds “have a role in a portfolio and are likely to become of more interest as the Baby Boomers continue to age.”

Retirement plans have traditionally offered either money market funds or stable value funds as conservative options, Evens says. However, in the past few years, advisers have become twice as likely to recommend stable value funds as money market funds, he says. This is because, due to the current low interest rates, money market funds have been delivering 0% performance net of fees, while stable value funds, which have an insurance overlay, have been delivering between 100 and 200 basis points (bps), he says.

However, with money market reform causing the funds’ net asset value (NAV) to float—and stable value funds becoming more expensive over time—some retirement plans have been “looking at hybrid solutions, such as short-term and ultra-short-term bond funds with various durations,” says Lorie Latham, defined contribution investment director at Towers Watson in Chicago. “We could see plan sponsors embrace other types of short-term instruments in the coming 12 to 18 months—even unconstrained bond funds or multi-manager bond funds,” she says. “They provide an improved risk/reward trade-off.”

Next on the scale of most- to least-moderate conservative choices would be intermediate bond funds that track a broad bond benchmark, Evens says.

The next tier is balanced funds and managed accounts, Evens says, followed by target-date or lifecycle funds. Advisers need to be especially careful when analyzing target-date funds, McCabe says. “Some TDFs for those in their 50s—even those in retirement—have as much as 50% to 60% of the portfolio in equities, partly because the funds are benchmarked against the S&P [Standard & Poor’s 500] and we have been in a bull market,” he says.

Target-date fund glide paths should become more conservative for those closer to, or in, retirement, Latham agrees. This is particularly important because 85% to 90% of plan sponsors use target-date funds as the QDIA. “That is where the vast majority of assets are going,” she says.

Other conservative choices advisers might think about recommending are Treasury inflation-protected securities (TIPS), Evens says. Latham believes real estate investment trusts (REITs) and diversified real return options could play a role in fund lineups, either on their own or integrated into a target-date fund. McCabe even thinks that some large-cap value equity funds could qualify as conservative options.

As to how many conservative options advisers should recommend to a plan, McCabe says, “There need to be at least several—perhaps three or four—including a money market fund, a short-term bond fund and some type of high-grade government bond.”

And as to how advisers should work with sponsors on selecting the right conservative choices for their plan, McCabe says it starts with “the investment policy statement [IPS], which will be their guide for the quality of investments. The [investments] need to be near the top of their peer groups, have a significant track record of at least five or 10 years and charge reasonable fees. That will shake out the list and narrow down the choices.”
—Lee Barney

Millennials Strive to Save
This group is in desperate need of advice and education

As Millennial workers are just getting started on a lifetime of saving, the industry has hopes that they—the first generation to be able to leverage a lifetime of 401(k) contributions—will be able to prepare adequately for retirement.

Automated features are a plan sponsor’s best resource for helping Millennials get the most out of a plan, says Judith Ward, a senior financial planner and vice president of T. Rowe Price Investment Services Inc. in Owings Mills, Maryland. “Millennials are using them, they need them, and they want more,” she says.

Ward says that 80% of Millennials believe the default deferral rate should be raised under automatic enrollment and that many wish they had been enrolled at higher percentages. The findings come from the firm’s new report examining retirement savings behaviors in different age groups, “Millennials, Gen X, and Baby Boomer Workers and Retirees: Retirement Saving and Spending Study.”

Millennials are novice investors, says Jerome Clark, a chartered financial analyst (CFA) and head of the T. Rowe Price target retirement funds in Baltimore, among other roles. “They want financial guidance because they are aware they’re lacking in financial knowledge,” he says. “They’re not getting financial education in school, in college or at home.” When they get to the workplace as new employees and new plan participants, they sometimes find themselves at sea.

Millennials have a gap in knowledge about finance, in general. From that perspective, “it probably doesn’t matter what investments they are defaulted into,” Ward says. “Plan sponsors need to educate them about target-date funds [TDFs] and what’s important about participating in the plan.”

This generation seems open to the idea of paying for professional financial advice. More than a third (38%) of Millennials say they have paid for financial advice in the last five years. “Since this generation was raised by Baby Boomers, they get a lot of their values from them,” Clark notes.

Another thing to keep in mind about Millennials, Ward observes, is that they are tech savvy. “They’re called digital natives for a reason,” she says, but they still like talking to someone one on one. This means advisers will need to think about how they do business with Millennials. She recommends reaching out to these investors online, using Skype and FaceTime.

Millennials’ deep engagement with social media means advisers might want to create more personalized experiences to interact with them. Ward says advisers could consider creating a profile that Millennials can view online. Additionally, this group’s love of gaming, peer review and peer recommendations presents various opportunities to creatively deliver information or connect. “They mistrust traditional advertising,” Ward points out. “They want authenticity.”

T. Rowe Price surveyed 3,026 working adults, ages 18 and older, currently contributing to a 401(k) plan or eligible to contribute and having a balance of at least $1,000, between March 4 and 25. The report also includes responses from 255 Millennials—ages 18 through 33—working and eligible for a 401(k) plan at their current employer but not contributing and without a 401(k) balance.

Source: T. Rowe Price

—Jill Cornfield