Speaking Their Language

One challenge of advising or designing a defined contribution (DC) retirement plan is that the whole idea of “retirement” can mean different things to different people.

According to the most recent PLANSPONSOR Participant Survey, 42% of workers subscribe to a traditional view of retirement—i.e., working until a certain age or until age limits their ability to work—while approximately 33% plan to keep working part-time. A more analytical approach to retirement, having enough saved to achieve sustainable financial independence, is cited 21% of the time.

These basic discrepancies can leave plan sponsor clients unsure of how to set goals or communicate the value of their retirement programs.

Each generation has its own set of challenges and priorities as well. For Millennials, retirement planning considerations may be tinged by the shadow of student loan debt or the desire to purchase a first home or car, or the simple need to establish financial independence and stability. For Generation X, many are “sandwiched” between parents and children, caring for both. Baby Boomers experience growing concerns about converting savings to a retirement paycheck—i.e., sequence of returns (SoR) risk and how to optimally shift to decumulation.

Understanding the issues that resonate most among each of the three age cohorts that make up the bulk of DC plan participants can help advisers consider how to help guide communications campaigns targeted at each, or even suggest changes in plan design.

Millennials’ Pressing Priorities

In the defined contribution plan industry, it is simply taken for granted that everyone should be saving more for retirement and that everyone should save as much as he can as early as he can. But, according to Andrew Biggs, resident scholar at the American Enterprise Institute in Washington, D.C., hardheaded analysis does not always agree with this. His uncommon message for plan sponsors and advisers is that Millennials who choose to forego plan participation, or to defer smaller amounts than the 10% or 15% of salary frequently recommended, often actually have a good reason to do so.

He says there are cogent arguments to be made that many young people who are expecting to earn more in the future than they do today should prioritize immediate needs ahead of retirement savings. For many Millennials, eliminating higher-interest credit card debt or paying down student loan debt takes precedence—or younger individuals with limited resources may decide to prioritize buying a home or building emergency savings.

“This is textbook economics, and the optimal balance between paying down debt and investing for the future can be figured out pretty easily,” Biggs says. “We don’t hear this discussion going on because, I think, the rigor of analysis among many of the people who are out there telling everyone to save all they can in the 401(k) all the time is, to put it mildly, lacking.”

Heather Coughlin, U.S. solutions leader for financial wellness at Mercer in New York City, agrees that employers and Millennial-age employees will both benefit from greater consideration of the debt issue. Short of offering student loan repayment benefits or broader debt counselling linked to the DC plan (see “Giving Them a Break”), employers might consider at least providing general education on the subject.

As Coughlin notes, the total amount of U.S. student loan debt has topped $1.4 trillion, including nearly $75 billion in PLUS [parent loan for undergraduate students] loans taken out by individuals on behalf of their children. In terms of work force percentages, fully 72% of employees say they have outstanding student loans or have successfully finished repaying loans while working.

“These numbers show that student loan debt repayment is among the top work force challenges in the U.S.,” Coughlin says. Citing her own statistics from within the Mercer book of business, she suggests the majority of workers who say they worry about their finances regularly also say debt has delayed or prevented them from saving for retirement.

It is not just Millennials taking lower-paying jobs who struggle to repay debt. From her perspective working with law firm clients, Naz Vahid, managing director and law firm group head at Citi Private Bank in New York City, says it is not uncommon to see younger married couples enter the work force with more than $1 million in combined student loan debt. According to Citi Bank survey data, twice as many people with student debt than without are worried about their personal finances, and, across all generations, financial worries drop drastically for people without student debt.

The upshot for advisers and plan sponsors is that communicating with participants about balancing retirement savings with more immediate needs is a necessary part of building a progressive DC plan. And, as not all Millennials carry significant student loan or credit card debt, other challenges can be addressed in communications as well.

Robert Johnson, president and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania, suggests Millennials’ other biggest challenge is risk aversion. Like the Silent Generation, who experienced the Great Depression, Millennials “were shaped by the cataclysmic financial event of the financial crisis of 2008, when they were just entering the work force,” Johnson says.

“The challenge here is helping Millennials’ overcome that risk aversion,” Johnson says. “Talk about market cycles.”

Gen X: Stuck in the Middle

Generation X, roughly those born from the early or mid-1960s to the late 1970s, faces many of the same debt challenges confronting Millennials. Additionally, though, they are stuck in the savings sandwich—called on to financially support both young children and aging parents during prime earning and saving years.

The sandwich challenge belongs to this cohort simply given its age range—and is heightened by the fact that Gen Xers established their careers during a period of difficult political and economic transformation. Investors and job seekers in Gen X faced down both the dot-com market crash of the early 2000s and the Great Recession credit crisis of 2008 through 2009 relatively early in their careers, leading many to miss out on earnings potential or to hold off on saving adequately.

According to the latest cut of data provided by Wells Fargo from its annual “Defined Contribution Study,” those in the sandwich generation of their family, defined by the firm as “people who are responsible for taking care of their aging parents as well as their own children,” are much more likely to cite rising health care costs as a major hurdle to retirement saving than those who do not have these responsibilities (30% vs. 18%). Sandwich-generation members are also more likely to cite higher health costs as a reason they fail to save more for retirement (71% vs. 56% of non-sandwich-generation workers). These are areas where plan advisers and sponsors can target communication campaigns and education efforts, the research suggests.

Catherine Collinson, president of the Transamerica Center for Retirement Studies in Los Angeles, observes that Generation X “is at an age when they are super-busy,” so building a focus on retirement planning can be a challenge.

“The critical mass of Gen Xers are in their 40s and are likely to be raising kids, perhaps looking after aging parents and paying off credit card debt,” she says. “They are more likely to have taken a loan from their retirement plan, and many are not saving enough. They are behind on retirement savings and need a wake-up call.”

According to the recent survey report “Moving the Needle: Targeting Generation X”—commissioned by Jefferson National, the advisory solutions business of Nationwide—among all members of Gen X, when asked about their top financial concerns, 46% cite saving enough for retirement; 28%, the cost of health care; 21%, financing their children’s education; and 20%, protecting assets.

Many of the things that financial advisers and plan sponsors can do to help Generation X are fundamental to retirement planning: Get them engaged by providing them with a calculator to estimate their needs. Do a gap analysis to set forth a plan that would put them in a better position to achieve their goals and get them to save more.

Similar to the support they can offer to Millennials, advisers can help Gen Xers analyze the interest rates they are paying on their various forms of debt versus the company match and potential growth of their retirement plan, Collinson says. Some forms of debt have a much higher interest rate, she notes. On the other hand, if an individual has more modest student debt structured at a low interest rate, this gives him an opportunity to optimize how he thinks about saving while paying down debt.

Cutting against some of the arguments made by Biggs, Collinson says it may not be a great idea to include Social Security as a main pillar of the retirement planning of Gen Xers and Millennials. “Social Security may look very different 30 or 40 years from now, and advisers and sponsors need to be very mindful of that when helping participants in their savings and retirement income planning,” she points out.

Baby Boomers Hit the ‘Red Zone’

For Baby Boomers, it is retirement planning crunch time, and, thus, many of them are already squarely focused on retirement readiness and eager for support. For their part, plan sponsors and advisers should remind Boomers to “be proactive to be employable by maintaining good health, performing well at their current job and keeping their job skills up to date,” Collinson says.

For those Boomers who have already met this year’s $18,500 contribution limit, advisers should also make sure they are aware of the additional $6,000 catch-up contribution they can make when 50 or older. Baby Boomers should also revisit their asset allocations to be properly invested for their age and risk tolerance. “Financial advisers and plan sponsors are in a wonderful position to deliver those messages,” Collinson says.

Johnson agrees that the proper asset allocation is critical for Baby Boomers, particularly within five years of retiring—when they are in the “red zone.”

“Take, for example, someone who retired at the end of 2008,” he says. “If they were invested in the S&P [Standard & Poor’s] 500, they would have seen their assets fall by 37% in one year. Just as a football team cannot afford to turn the ball over and fail to score points when inside the opponent’s 20-yard line, the retirement investor can’t afford a big downturn in the retirement red zone. This is what is referred to as sequence of returns risk. Taking risk off the table right before retirement is a prudent move.”

Related to sequence of returns risk is decumulation of assets. Advisers and plan sponsors need to help retiring Baby Boomers create a drawdown strategy, Collinson says. “Relatively few plan sponsors offer an annuity as a payout,” she observes. “This is something for them to consider. If they are concerned about fiduciary liability, they can at least provide information about the types of retirement income strategies available and point participants in the right direction.”

Thomas Dodd, executive director with Pavilion Advisory Group in Chicago, emphasizes the importance of plan officials taking time to compare and contrast common retirement income strategies—defining the pros and cons of each method as viewed from the perspective of Baby Boomer participants.

“The first step is to encourage pre-retirees to develop a withdrawal plan, in contrast to withdrawing money in an impulsive manner based solely on immediate spending needs,” he suggests. “Retirees may have a feeling of wealth when they see their account balance but not realize how little it provides when converted to an annual income. To help ensure a retiree does not run out of money, a systematic withdrawal plan is preferable to no plan at all.”

A withdrawal plan should be developed with attention to the risks that increase the likelihood of running out of money. These include, but are not limited to, longevity risk, investment risk, inflation risk, liquidity risk, standard of living risk and behavioral risk, Dodd says.

“There are a limitless number of withdrawal plans available to retirees, but we tend to focus on those that have gained at least some acceptance and usage and, most importantly, are rules-based,” he says. “These withdrawal plans fall into three categories: investment earnings, systematic withdrawals and annuities.”

Under the investment earnings approach, interest and dividends are withdrawn and form the basis of retirement income. The principal of the assets is left intact. A variation of this is to also withdraw the realized capital gains. The second approach, systematic withdrawals, involves a rules-based strategy that is managed either by the retiree or an adviser. These strategies also generally fall into three categories: constant dollar amount, the endowment method and the life expectancy method.

Annuities, the final approach, can be explained simply as a series of payments at fixed intervals guaranteed for a fixed number of years or the lifetime of one or more individuals; the options available to retirees are plentiful.

“Which of the three withdrawal strategies should a retiree choose? There are advantages and disadvantages to each, and the trade-offs can be analyzed across four dimensions,” Dodd concludes. “Is the level of income provided adequate? How predictable is the income amount? How liquid are the retiree’s assets? And what level of advice or guidance does the retiree want?” 

Art by Jillian Tamaki