Retirement security: An inflection point.

Transcription

1 Institutional Retirement and Trust. Retirement security: An inflection point. by Joe Ready, Executive Vice President, Director, Wells Fargo Institutional Retirement and Trust. By now most people are aware that workplace pensions have largely been replaced by 401(k)-type defined contribution retirement plans. The significance of that change is that it places considerable responsibility for retirement saving upon the individual and it becomes clearer every day that many of those individuals need help. In a changing and dynamic retirement plan marketplace, responsible companies are rising to that challenge by mounting sophisticated programs to encourage best retirement practices among their employees. Income sources in retirement Traditional and Roth IRA 9.7% Personal savings and brokerage 9.7% Defined benefit 9.8% Part-time employment 11.4% Other 2.6% Source: Cerulli Associates TODAY Social Security 33.9% Defined Contribution 22.8% Traditional and Roth IRA 9.7% Part-time employment 11.4% Personal savings and brokerage 9.7% TOMORROW Other 2.6% Social Security 33.9% Defined Contribution 32.6% Since they were created more than 35 years ago, 401(k) plans have seen rapid change. They ve evolved from what originally was a voluntary retirement benefit to become the primary workplace retirement benefit, now available to 58% of American workers. 1 But if you think 401(k)s have developed over those initial years, hold on to your seat. I actually think we re in for another round of really rapid change over the next five years change that will transform how Americans save for retirement and how plan sponsors adapt to serve them. Major forces are converging toward what I see as a key inflection point for retirement security for millions of Americans. To begin with, take a look at current and future income sources in retirement. Today, as you can see, about 57% of mass market Americans retirement security, or income, is coming from Social Security and defined contribution, 401(k)-type plans. Notice that about 10% of other income is currently coming from defined benefit plans (pensions). But in the near future, something dramatic is going to happen. That 10% source from defined benefit plans is going to disappear and defined contribution plans will expand in importance from roughly 23% of income sources to nearly a third of income roughly equal to Social Security. That s a 43% increase in defined contribution plans as a source of retirement security, to the point where more than two-thirds of the money retiring workers have in the future will come from Social Security and their company 401(k). When you look at it that way, and factor in questions about the prognosis for Social Security, that one-third future source from defined contribution plans becomes really important. While we re looking at sources of income, I want to debunk a prevalent myth. Notice that in both the today and tomorrow scenarios more than 11% of income is expected to come from part-time employment. In aggregate that may be true, but I don t think the individual can rely upon that. First there s the question of whether the employee wants to keep working. But beyond that are questions of whether they can keep working. Do they have the physical well-being to work? Are they, in their 60s or even 70s, up to the mental and physical demands of the corporate or small business workplace? We see this response in surveys all the time: If I don t have enough I ll just keep working. From an individual s standpoint, there may not be that option. Half of today s workers expect they will need to work until at least 70, but 46% of retirees say they had to retire sooner than expected. 2 Going forward, if you think about it, the real reliance for retirement security is on the workplace plan.

2 Forces of change. Four major forces are converging to drive change in the retirement plan marketplace: policy developments, social issues, technology innovations, and regulatory changes. 1. With regard to policy, you have to begin by recognizing that the primary retirement plan for middle America is the defined contribution plan. That s the reality of what we re living with today. And the good news is that by now we have plenty of evidence that the workplace defined contribution retirement plan works, if used appropriately. Can the workplace environment be improved? Of course. One of the great weaknesses and opportunities for development centers on access. If you think about the roughly 125 million Americans working full-time today, 3 more than 40% don t have access to a workplace retirement plan. That s big. We re looking at what may be a more than 50 million person gap, and if you re a policy maker you can t leave that many people behind. That s why you re seeing ideas in Washington, D.C. around the formation of state retirement plans and lots of discussion around multiple employer plans or what is now commonly referred to as Pooled Employer Plans or PEPs. It s a real industry issue and one that we need to step up and help solve. I actually think PEPs consistent with the successful defined contribution model can play a really big role in closing that gap. The other issue that s being bandied about from a policy standpoint regards savings rates. Access to systematic saving via workplace plan payroll deductions is a first key step. But we all know that savings rates aren t high enough. Tax reform is one way Washington has been thinking about addressing this. I really worry that if we re going to pass tax reform to lower the corporate tax rates or lower personal income tax rates, one of the things that will be coming into the crosshairs of policy administrators as a funding source is a restriction of 401(k) deferrals. There has been some discussion about making all 401(k) deferrals 100% Roth deductions. I ve seen projections that this change will generate $543 billion in tax receipts to help pay for projected tax reform. The flip side of the change begs the question as to whether people will be better off with the trade of lower income taxes to offset the Roth impact. My concern is we ve spent 30 plus years educating a whole workforce on the power of tax-deferred savings. Now, if that 401(k) contribution is taxed, if earnings and growth on it are taxed and not deferred, there s some math in there that has to be worked out. What happens to the incentive to save? I think there are things we have to think about as an industry from a policy standpoint. 2. Social issues are a second major force driving change. We tend to think in terms of generations when we talk about social forces: Typically, Millennials like digital information and Boomers want face-to-face interaction. But there are a lot of people in these broad generational groupings, and they don t all think and interact the same way. For example, many Millennials do like to receive a lot of their information digitally, but we ve found that when it comes to making a decision, many of them like face-to-face or telephone interactions to corroborate their opinions about the digital information they ve received. There are a lot of people in these broad generational groupings, and they don t all think and interact the same way. These social forces aren t so much generational as they are situational or generational challenges. No matter what generation participants might be part of, we need to understand their preferences. How do they want to interact? What issues are important to them? We need to understand that the challenges they face are very different. Boomers might be thinking of when to take Social Security or how to draw down their money. They were always Boomers, but they weren t always thinking that way; that s what they re facing now. According to a recent report, Millennials graduating from public colleges have an average of over $30,000 in debt. 4 For many of them, that s their current challenge. And when we say, Join your plan. Save as much as you can, their response is often I d love to, but my college debt is not optional. Debt isn t always going to characterize Millennials; it s what they re facing now. Whether the participant is an early saver, just starting a career, mid-career, in the sandwich generation, or on the verge of or in retirement, these generational challenges are important to address with targeted messaging specific to their situation. 3. Technology is a third major force driving change, and it s rapidly engaging us in every facet of our lives. We can t assume that because we can do something with technology that people will use it. We have to constantly assess whether the technological solution is bringing us closer to our clients with better understanding, better reporting, easier, smarter interaction that drive better outcomes or pushing them further away through mass communication and impersonal interfaces. On the other hand, we must explore the rich opportunity technology provides for us to know and serve our clients. How do we put information at their fingertips that s highly personalized, targeted, relevant, and timely to make their place in the retirement journey real? How do we make complex things simple? We used to do participant enrollment in multiple steps from desktops, and at one time that was a very modern thing to do. But now, with mobile, we ve moved to a text with two steps that you can do on your phone. And guess what? Our enrollment rate jumped dramatically. I believe we are just beginning to leverage the power of technology and tools like artificial intelligence that will dramatically change how we interact with participants. That s technology enhancing the relationship, making things easy. 2

3 4. Regulatory revisions are the fourth major force driving change, particularly in the area of proposed Department of Labor (DOL) changes. In defined contribution plans we have safe harbors and all these protections in place to ensure that the independent fiduciary on retirement plans is always acting in the participant s best interest. But after 25 or so years of saving, the participant has historically lost the DOL protection if he/she rolls their savings over to an IRA. And I think the DOL s position is, We re not sure we re comfortable with that. So a big part of the DOL fiduciary role is to say the Employee Retirement Income Security Act (ERISA) rules and DOL protections will expand to include all retirement assets. The status of the DOL changes and the potential effects of those changes are still unfolding. But potentially the DOL changes mean IRAs are going to have to compete with the services and cost structures that qualified plans provide today. And those cost structures are very different, primarily because the IRA is a oneon-one sale, where the qualified plan is a group sale, with group benefits in terms of pricing from an asset and service standpoint. We think that has the potential to be good for the consumer, both from a cost standpoint and from a service standpoint with fiduciary protection in a conflict-free environment. But potentially the DOL changes mean IRAs are going to have to compete with the services and cost structures that qualified plans provide today. The right kind of focus. All of these major sources of change in the retirement industry are sometimes overshadowed, I think, by the threat of litigation in the form of class action lawsuits against plan sponsors relative to fees. In the industry, we re all familiar with media attention given to lawsuits in the large plan market. The last time I counted, there were a dozen or more active lawsuits involving plans with a billion or more in assets. I believe the threat of litigation is a driving force behind the move to passive investment strategies. When you ask large plan sponsors why they re choosing passive investments, as Cerulli Associates recently did, 41.3% of large plan sponsors said they were moving to passive investments to alleviate the threat of lawsuits, 33.3% said cost of investments was the most important factor which could also mean they re trying to avoid lawsuits and 16% said they had fiduciary concerns which also sounds like they don t want to be sued. Only 9.3% said they believed that active managers can t outperform passive strategies. Why large plan sponsors are choosing passive investments Active managers can t outperform 9.3% Fiduciary concerns 16.0% Cost of investments is the most important factor 33.3% Source: Cerulli Associates Alleviate threat of lawsuits 41.3% And this isn t just a large market phenomenon. Recently there was a lawsuit filed for a plan that had just $10 million in assets with 100 employees. I m hoping regulators will put forward some guidelines to say Hey, we have a way to help you determine reasonable fees to protect you from that. Eventually I think that will happen, but one thing I do know is that cheaper is not always better. One of the things I wake up every day thinking about is: How do I help America s diverse workforce prepare for a better retirement? And one of the best ways to do that is to focus upon outcomes, the components of which are very straightforward: Participation: Are they in the plan? Contribution Rate: Are they deferring at least 10%? Diversification: Are they adequately diversified? But while sponsors might care about those measures, participants want to know how much money they re going to have in retirement. Research shows that for a majority of people, 80% pay replacement is a good place to start, so the goal of all of this is 80% replacement and, hopefully, a measure of retirement security. From the participant s standpoint, that s the outcome. While I believe the retirement industry understands the importance of outcomes, I would challenge us to ask if what we do and say is consistent with the Plan Health practices we put in place and if our energy is properly focused. If what the participant is looking for is that 80% income replacement outcome and what the industry is focused upon is costs, are those two goals complementary? 3

4 Allocation of all in fees. 1.20% 2014 Average All In Fees 2016 Average All in Fees 2016 Average RK BPs Allocation of plan costs: Out of balance? Cost 80% pay replacement demand/value 1.10% 0.89% 0.75% 0.67% 0.58% 0.53% 0.44% INVESTMENT EXPENSE $0.80 PAY REPLACEMENT $0.20 $1M $10M $10M $100M Source: Wells Fargo Internal Analytics. $100M $500M $500M+ This chart looks at statistical data from Wells Fargo s retirement plan business. The tan top line represents 2014 all-in fees, including all the fees in a record kept plan by market segment: investment fees, recordkeeper provider fees, advisor fees, and any fees associated with the administration and offering of the plan. The top of the green bar represents 2016 fees, so the first point I would make is, regardless of segment, fees have compressed from 2014 to 2016 by roughly 8% or 9% on average. Now, if you focus on 2016, we ve got the average costs split between investment manufacturing costs (the green component) and recordkeeping costs (the blue component). Investment manufacturing costs, the larger component, include pure investment expenses: the mutual fund, collective fund, whatever the investment cost is in the plan, plus advisor costs, if applicable. The smaller component, in blue, are recordkeeping or administration costs: all the activities around education, oneon-one consultations, guidance, help all the things we do to try to get people in a plan, save 10%, and allocate appropriately. And you can see that roughly 80 cents on the dollar is being spent on investment manufacturing costs and only 20 cents on what I ll call pay replacement, including the biggest drivers of participant outcomes. And it feels upside down to me. It s like spending 80% of your money building airplanes and only 20% teaching people to fly them. You know, you want a good plane, but you also need a good pilot. Key drivers of retirement preparedness. The key drivers of retirement success can be summarized in what seems at first to be a simple formula: Accumulation Decisions (savings and investing) + Decumulation Decisions (monthly income in retirement) = Optimum Outcome. Historically, our industry has been accumulation centric. We ve grown to roughly six-and-a-half trillion dollars in defined contribution assets, and it s projected to be over $8 trillion by So we ve done a really good job of focusing upon savings rate, asset allocation, investment performance, and fees. But the second part of the formula is what I call hedging longevity, or decumulation, and that s where a lot of really important decisions get made: 25 to 30 years of great savings and investments can be jeopardized by bad decisions on the distribution side of the equation. At what age should I retire? How much can I afford to withdraw every month? When should I take Social Security? Should I withdraw first from my taxable accounts or my tax-deferred accounts? Should I follow a pro rata formula? How do I think about sequence of returns? How do I actually get the money and what about this thing called longevity, which is not individually predictable? So accumulation is only half of the equation and you ve got to think about the whole equation if your goal is to maximize outcomes. Formula for success. SAVE FOR RETIREMENT. Accumulation: Savings rate, Asset allocation, Investment performance, Fees. + HEDGING LONGEVITY. Decumulation: Retirement age, Withdrawal rate, Social Security, Taxes, Sequence of returns, Longevity. = Outcomes. EARLY SAVER MID-CAREER PRE-RETIREE RETIREE

5 The retirement security inflection point RETIREMENT SECURITY OUTCOMES COSTS...to what end? And here I want to address a central concept of retirement, what I call the Retirement Security Inflection Point. As noted earlier, we should be focused upon outcomes, but that can be a tall order for someone in their 20s, just starting out with few assets. That person is probably more focused upon paying the rent than calculating a Social Security payout in 40 or so years. On the other hand, we have research showing that plan participants typically engage in a spike of activity five or six years before retirement, and again in the last two years immediately before retiring. The problem here is that it s difficult to make meaningful adjustments that close to retirement. People start thinking about retirement outcomes way too late. To really impact retirement outcomes, you ve got to connect with the participant when he/she has enough assets and experience to have thought about retirement seriously, but early enough so that they can have an impact. For most people, I think it s really important to start thinking about what age they want to retire and all the related questions much earlier, by age 45. At that age they can still bend the curve toward improved outcomes by following a well-designed plan so they can retire on their terms. And we as an industry have the ability to draw attention to that age, when retirement still seems far off, and to highlight the importance of thinking ahead. When you think about focusing your retirement efforts it s important to identify the key drivers of retirement outcomes. I think savings rate has got to be number one. I m fond of saying you can t invest your way to retirement. You have to save. But of course, you can t just put that money in a savings account you also need to invest and you need to diversify when you invest. And the earlier you start, the better. So those first three drivers savings rate, asset allocation, and age/stage are all central to accumulation. Beyond those three are drivers that tend to have less impact on accumulation, but they re important. Withdrawals require a strategy. Many participants think they can withdraw 10% in retirement. That might be okay if you don t retire until your late 70s, but for most people it s not going to work. Impact of investment performance vs. saving age Monthly Income $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 Starting at age 25 $6,796 $9, $11,242 Starting at age 33 $4,897 $6,656 $8, Rate of Return: Low (6.75%) Mid (7.00%) High (7.25%) Source: Wells Fargo Internal Analytics While plan fees and investment performance will perhaps always be centers of attention, it s important to focus upon the key drivers to help maximize retirement outcomes. A worker who begins saving at age 25 might generate a monthly income of $9,171, with relatively little difference in outcome whether he/she enjoyed 6.75%, 7% or 7.25% returns (see chart above). But that same worker with the same returns would face a reduction of more than $2,500 in monthly income if he/she waited eight years to begin investing. Savings rate, asset allocation, and the age workers begin investing are more likely to impact retirement outcomes than minor differences in investment performance, fees, and taxes. And notice that it s not just about starting early and this is where that inflection point comes into the picture. If you are able to retire later you can make up for a late start to some extent. Or, if you re in your late 40s you can step up that curve and bend the outcome. The point is time is your biggest asset and you can make a difference if you look at this early enough, and you don t have to be a kid in your 20s to do it. The power of time is a really important lever, and I think we can do a better job of bringing that Key drivers for maximizing retirement outcomes FEES INVESTMENT PERFORMANCE WITHDRAWAL STRATEGY AGE/STAGE ASSET ALLOCATION SAVINGS RATE LEAST IMPACT GREATEST IMPACT 5

6 to light much sooner not only on how much it helps you on the savings side, but also what it can do for you on the distribution side in terms of retirement age. Drivers of participant outcomes Years saving will last at 80% Model Fees 50% higher (108 bps) Examples are for illustration purposes only. Estimates are based on the assumptions noted, do not guarantee or imply a projection of actual results, and do not include the effect of taxes and fees. Wells Fargo cannot guarantee results under any savings or investment program and cannot guarantee that plan participants will meet their retirement savings goal. Source: Wells Fargo Internal Analytics Model participant Qualified Automatic Contribution Arrangement (QACA) safe harbor match Fees of 72 bps Enrolls at age 25 Defers at 6% 7% investment return Overconservative (5% return) Starts participating 10 years later (age 35) 11.4 Defers half as much (3%) We compared the number of years savings will last at 80% income replacement for a model participant, for another who was paying too much in fees, for one who was too conservative in investing, one who started participating late, and one who deferred only half as much as the others. Our model participant in this comparison has a safe harbor match of 3%, is paying fees of 72 basis points, started saving at age 25, deferred 6% of income and was appropriately allocated to generate an average annual return of 7%. By retirement age, the model participant has savings to last 22.8 years at an 80% rate of income replacement. As this chart demonstrates, an overly conservative investment mix, a late start, or a low deferral rate affecting the key drivers can reduce participant outcomes by 50% to 60%, while a 50% increase in fees results in only an 8% reduction in the years savings will last. I don t want to minimize that fees are important but you can see that selecting the least expensive plan is no guarantee of freedom from litigation, and that fiduciary decisions need to consider more than cost. Sponsors should review all products within their plan but should focus upon value and consider whether they need to do more to help participants. The good news is that the most important drivers of retirement outcomes are largely within the participant s control: how much is saved, where it is invested, and at what age he/she begins. And for plan sponsors, the focus needs to be on addressing those behaviors. Challenges of decumulation. Anyone who thinks the accumulation side is hard hasn t seen anything until they ve addressed decumulation. That s an area where you can take 25 years of great accumulation and savings behavior and ruin it by making a couple of bad decisions. Baby boomers, for example, have been caught in the squeeze between the decline of pension plans and the advent of defined contribution plans. Six out of 10 baby boomers have saved less than $250,000, 6 yet three out of 10 haven t done any retirement planning for distribution or decumulation. 7 In fact, America s top three retirement fears 8 are all on the decumulation side: 1. Outliving income. 2. Maintaining lifestyle. 3. Healthcare costs. When you ask participants what help they want to address those fears, the top five topics are all about decumulation: Social Security, healthcare expenses, developing monthly income from investments, understanding if they ll outlive their money, and ways to guarantee portions of their income. This year we asked participants what it would take for them to stay in plan 9 and among the things they asked for was more personalization, help, and guidance. They want to talk about their investments. They want to get many questions answered. They want to build a rapport and a relationship with someone and they want to feel comfortable and get personalized one-on-one help or advice. So interaction is really important. Topics participants need help with. 1 Social Security 45.5%. 2 Healthcare expenses 37.9%. 3 Developing monthly income from investments 35.8%. 4 Understanding if they will outlive their money 25.9%. 5 Ways to guarantee portions of income 23.0% 6 Evaluation of progress toward funding retirement 21.0%. 7 Financial professional is handling retirement income plan 13.1%. 8 Budgeting assistance 10.8%. 9 Leaving a legacy to future generation 8.5%. 10 Other 8.1%. 6

7 Earlier I mentioned regulatory and other forces that are making it more attractive to stay in plan upon retirement or separation from service. When we asked plan sponsors if participants should stay in plan, it s no surprise that many were positively disposed. Then we asked plan participants, and many of them thought it was a good idea. Potential advantages for the participant include an independent fiduciary, access to institutionally priced investments, and all the education and advice services provided at the group plan level. But the number one issue preventing participants from staying in plan was that nearly one in two plans currently had no income option. So that s an interesting dynamic: I want them to stay, but I m not offering them an income option which I know they need. Is your plan design and service focused on the formula? Auto: Enroll, Defer 6 10%, Increase, Rebalance (include company stock). Asset allocation: Target date, Managed accounts, Advice offering. Budget. Income simulation. Age/stage focus. Social Security. Longevity. Income producing investment options. Retirement paycheck development. Sequence of returns, taxes, withdrawal strategy. Inflation protection. That, I think, is going to change. Another quarter of sponsors said they already had a retirement income offering in their plan or said they were planning to add one. That trend is building. And I think the implication of the DOL rule and other forces is that more people are going to stay in plan, resulting in more in-plan retiree services, with more in-plan guaranteed income streams, and more help with budgeting, Social Security decisions, and dealing with uncertainties around longevity. The whole retirement picture. A majority of workers have a 401(k) plan or equivalent, and participation in employer plans has historically shown to lead to strong results. For those with access to a 401(k)-type plan, the median amount saved is $87,000 vs. $10,000 for those without access to a plan. In the 2016 Wells Fargo Retirement Study, we found that middle income workers (those with less than $75,000 in household income) with access to a 401(k) plan had saved 30 times more than their peers without access to a retirement plan. 2 Nearly three out of four workers (73%) indicate they wouldn t have saved as much for retirement if they didn t have a 401(k) plan or would have saved more if they had one. 2 Statistical analysis has demonstrated that participants who consistently meet the three key behavior standards participate, contribute at 10%, diversify appropriately are much more likely to achieve an income replacement of 80% or higher in retirement than those who do not. Influencing these behaviors is the best means plan sponsors have for helping employees prepare for retirement. You have to think of accumulation and decumulation to optimize outcomes to think to and through retirement. We want to make sure we re surrounding people at all stages with the help they need, answering their questions, always with an eye on the end result. I m excited about where the industry s going. I m thrilled to be part of it. I think the next five years are going to be incredibly exciting, and I think they offer tremendous opportunity for participants and sponsors alike. Joe Ready. Joe Ready is executive vice president and director of Wells Fargo Institutional Retirement and Trust. In this role, Joe has responsibility for products and services for more than 5,000 employer-sponsored retirement plans and custody accounts with 4 million employees representing almost $750 billion in assets, supported by nearly 2,000 team members with a mission to help America s diverse workforce prepare for a better retirement. Joe has more than 30 years of leadership experience in relationship management, sales, investments, trust administration, operations, and systems. He has served in a variety of leadership roles in the institutional and investment areas including the mutual funds business, pension and employee benefits, and institutional custody. He earned a bachelor s degree from Franklin and Marshall College. Joe is active in the retirement industry as a speaker and participates in several executive industry trade groups and boards. He currently is Co-Chair of the Wells Fargo Bank, N.A. Trust Committee. He is also president and board member of The SPARK Institute, Inc. Joe volunteers in the Charlotte, North Carolina, area with various charitable functions and is currently a board member on the College of Charleston Parent Advisory Council. Over the last several years, Joe has been named one of the 401(k) industry s top 100 most influential people by 401(k)Wire. 7

8 1 The Pew Charitable Trusts, Who s In, Who s Out, A look at access to employer-based retirement plans and participation in the states, January Wells Fargo Retirement Study. 3 Statista.com, Monthly number of full-time employees in the United States from 1990 to 2017, April The Institute for College Access and Success, Student debt and the class of 2015, October The Cerulli Report, U.S. Retirement Markets, December Mintel Retirement Planning, U.S., May Mintel, Boomers and finance, Greenwald & Associates focus groups, May Wells Fargo Institutional Retirement and Trust, Stay in Plan research, March Wells Fargo Bank, N.A. All rights reserved. IHA