Investment Insights Series A New Approach to Addressing Key Challenges Facing Today s Retirees and Plan Sponsors Summary Plan sponsors invest in their employees: they spend time and resources on costeffective, quality health care; offer career training and tuition assistance programs to help promote job growth; and contribute to their employees retirement. As retirement assets have increasingly shifted from Defined Benefit Pension Plans to Self-Directed Savings Plans (e.g., 401(k) plans), these plan sponsors, along with their consultants and asset managers, have continued to adapt their retirement offerings to meet evolving participant needs. Many employers have redesigned the investment menu, while others have increased the dollar amount contributed to an employee s retirement. Whatever the approach, plan sponsors know that retirement savings programs are a significant part of an employee s total benefit package, and they want those programs to be successful. Further, as the baby boom generation ages, more and more participants are near, or even past, the traditional retirement age of 65. These participants want to be selfsufficient and enjoy their retirement but are concerned about their ability to live on their retirement savings and so are plan sponsors. To live well in retirement, the majority of retirees will need to see continued growth of their assets during their retired years. And for participants who move assets out of their employer sponsored plans, the impact of fees could cost them years of savings. Participants at or near retirement are also realizing that their spending needs will be different compared to their working years. Finally, they know that their income needs will change throughout retirement, especially with the unknown cost of retiree health care. The defined contribution (DC) industry is putting enormous resources behind the challenge of participants depleting their DC assets too early. For participants who started saving early and stayed invested throughout the recent market turmoil, purchasing a guaranteed income vehicle may be their best solution. But participants who cannot afford a guaranteed income solution, or who want to maintain control of their assets in retirement, also need an investment solution preferably an in-plan solution. In this brief, we suggest a different approach to the retirement income challenge. We believe that retirees and plan sponsors would be well served by asset allocation-type solutions tailored specifically for the retirement years. Such solutions could offer an economic benefit by helping sponsors retain assets in the plan. And retirees could benefit from tailored strategies that are customized to meet their diverse retirement needs: asset growth, risk management, control over their assets, and flexible spending all while helping to minimize the chance that retirees will outlive their assets. Read Inside The importance of differentiating participant needs at and throughout retirement Cost and scalability advantages to keep retirement assets in-plan, potentially benefiting plan sponsors and participants Addressing asset growth needs by shifting from guaranteed income to decumulation strategies
Introduction Retirement income for Self-Directed Savings Plans (e.g., 401(k) plans) has been a pressing challenge for years. But it is especially acute now that we face a surging population of pre-retirees aging baby boomers who will be retiring soon and may not have sufficient savings to support themselves in retirement. Baby boomers currently make up 31% of the workforce, which is roughly the same as the millennials (born between 1980 and 1996) and Generation X (born between 1965 and 1979). 1 The baby boom generation is typically defined as people born between 1946 and 1964 we are only now seeing the oldest of the baby boom generation retire today. Births peaked in 1957 when over 4.3 million babies were born these workers are only 57 years old today. As shown in Exhibit 1, the percentage of the American population over age 65 will soon increase significantly, so while we are beginning to see the early challenges of retiring baby boomers, it is only the early innings. Exhibit 1: Percent of U.S. Population 65+ 25% The self-directed landscape has historically been focused on creating effective solutions for the accumulation stage (a participant s working years). Yet, given the change in participant demographics over the past 30 years, we now face a gap for the decumulation stage (a participant s retired years), as shown in Exhibit 2. Exhibit 2: Self-Directed Savings Landscape by Age High Growth Need/Risk Tolerance Low Growth Need/Risk Tolerance Diversified Equity Funds Target Date Funds Balanced Funds Decumulation Strategies: A Missing Piece of the Retirement Puzzle Fixed Income Guaranteed Income 25 35 45 55 65 75 85 95 20% 2016 Accumulation Near Retirement Retirement/Decumulation 15% 10% 5% 0% 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 Source: U.S. Administration on Aging. 2 To close the gap, plan sponsors and investment managers have dedicated enormous resources to designing guaranteed income solutions, but those have found little traction in the market. We believe this is in part because the amount of retirement assets are low, driving a need for growth; therefore, guaranteed income solutions only meet the needs of some retirees. But there is quite a lot that we can do right now to address urgent issues around retirement income especially for those retirees who cannot afford guaranteed income. Customized decumulation strategies could offer many benefits to both participants and plan sponsors. For participants, these strategies can potentially generate needed asset growth throughout retirement. Greater growth may allow them to enjoy retirement without relying on family or children. It can also help address changing spending needs as retirees age. Additionally, the lower costs of 401(k) plans compared to IRAs can lead to further improvements in retirement outcomes. For sponsors, these strategies can better help them meet the needs of all participants, especially as more employees approach retirement and retire later. Finally, keeping assets in the plan can also help sponsors reduce overall plan costs. 1 Gallup.com/Gallup daily tracking survey. As of 1/20/14. 2 Based on U.S. Census Bureau data for 1900-2000, and U.S. Census Bureau projections for 2010-2050 (published 2008). Page 2 of 7
As an industry, investment managers have been highly innovative in designing solutions for DC plan participants accumulation years. We can easily apply that same knowledge and innovative spirit to participants decumulation years. Ultimately, we believe that tailored, multi-asset decumulation vehicles offer a unique combination of benefits: they are cost efficient, flexible, easily understood, easily adopted and aligned with participant preferences. They could be a win in every category that matters but especially for those who most need our help: America s retirees. Working Within the Limits of Participants Savings & Preferences DC plan sponsors and investment managers have been working overtime to address participants low savings rates using approaches like auto-enroll and auto-escalate, and increasing employer matches. We are optimistic that these approaches will continue to evolve to help younger workers save in the 12% to 15% range annually. Participants who are at or near retirement age, however, have typically saved at a much lower rate, and started saving later in their careers. This creates a challenge for plan sponsors as they are seeing employees work longer; yet, there is an opportunity to offer more outcome-oriented investment solutions for these participants recognizing their investment needs are different and not static. Consider the scope of the challenge: defined contribution account balances are increasingly in the hands of retirees; by 2016, a majority of participants will be over the age of 65, and a majority of 401(k) balances will be in the hands of participants who have retired and/or separated from the company. 3 Yet, even considering that 401(k) balances are just one leg of a three-legged stool (Social Security and personal savings being the other two), current balances are too low to purchase an annuity with a sufficient level of income. During the first 10 years of retirement, the typical retiree s spending is approximately $46,000 annually. But at today s interest rates, an annuity generating that level of guaranteed income would cost a 65-year-old participant approximately $1 million.⁴ As shown in Exhibit 3, the median 401(k) account balance for pre-retirees age 65 and older was approximately $68,000 as of year-end 2015.⁵ When annuitized, this equates to only about $283 in monthly income and slightly more than $3,400 in annual income less than 10% of the income needed by the average retiree. Exhibit 3: Current Savings Gap Age Traditional Retirement Age* Median 401(k) Balance** Estimated Annual Income from 401(k) (Annuitized @ 65)*** Anticipated Social Security Income ($50K Salary) Average/Shortfall (Versus average spending of $46k per year) 55 67 $71,579.00 $4,728.00 $19,008.00 ($22,264.00) 65 66 $68,558.00 $3,384.00 $16,752.00 ($25,864.00) * Based on current retirement age and calculator provided by SSI. ** 401k Balance figures taken from How America Saves 2016, p.45. *** Estimated using Age and Median 401k balance - Blackrock.com/cori-retirement-income-planning. Benefit calculated to be $1584/mo for 55, $1396/mo for 65. Source: Calculated by Janus Henderson Investors using Vanguard, SSI and BlackRock CoRI Index figures. As of 1/9/17. 3 Cerulli Associates Quantitative Update: Retirement Income 2011. 4 BlackRock CoRI Index. 5 Vanguard: How America Saves 2016. Page 3 of 7
Thus with today s low account balances, the average participant buying a guaranteed income product faces a significant income shortfall, even taking into consideration potential Social Security payments. Based on current and historical personal savings rates, it is unlikely that participants have saved enough to make up a shortfall of more than $20,000 per year. Such shortfalls are particularly acute for lower-earning seniors, but income shortfalls are by no means limited to low-earners or even average participants. The income picture looks quite dire for most pre-retirees, who make up 38% of the 401(k) population. Currently, only 10.2% of all 401(k) participants have account balances greater than $100,000. Even if we assume that all 10.2% are pre-retirees, that means that two-thirds of pre-retirees have balances of less than $100,000. 6 We also need to examine participant demand for guaranteed income products. Evidence from the defined benefit (DB) channel is telling in this regard. Though one might assume a majority of traditional DB and Cash Balance (CB) plan participants would select an annuity, EBRI reports that from 2005 to 2010, only 27.3% of participants with no restrictions on lump sums elected an annuity. As shown in Exhibit 4, older workers (age 50-75) do not always elect annuities more frequently. Exhibit 4: Percentage of Workers Who Elect An Annuity Age Defined Benefit Plan (%) Cash Balance Plan (%) 50-54 12 8 55-59 22 18 60-64 29 37 65-69 37 68 70-75 25 30 Source: EBRI Issue Brief January 2013. No. 381. Large segments of the DC plan participant pool and one could fairly say the vast majority of DC plan participants cannot afford sufficient guaranteed income; additionally, we believe many participants would not choose guaranteed income solutions even if they were offered. Offering these participants greater flexibility in managing their retirement assets in-plan can allow them to build savings earlier in the retirement years and, as shown in Exhibit 5, increase the amount that can be withdrawn for retirement each year. Exhibit 5: Hypothetical Increase in Annual Retirement Income Over 30 Years Additional Annual Withdrawal $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 Increase in Asset Growth 0.5% Growth 1.0% Growth 1.5% Growth 2.0% Growth 2.5% Growth $100,000 $200,000 $300,000 $400,000 $500,000 Starting Retirement Account Value Assumptions: Starting asset earns a baseline return of 2.5%. Income amount is annual withdrawal amount that brings the account value to $0 in 30 years. Assumes 2% growth of starting expenses. Plan Sponsors Face Challenges as Well Investment managers have come a long way in understanding the resource and cost constraints affecting DC plan sponsors. With today s multi-asset solutions, we have helped bring institutional approaches to the DC plan market, at affordable pricing with simplified oversight. Yet cost pressures and resource constraints are still weighing heavily on plan sponsors and require ever-more attention; their DC committee agenda is already packed with issues such as choosing investment options and managers, designing plan features and benefits, benchmarking performance, providing fiduciary and regulatory oversight, and managing participant education. Increasingly, sponsors are also dealing with more complex investment issues, such as selecting or even designing custom target date series; adding and/or designing target risk and other multistrategy vehicles; and adding sophisticated alternative strategies and vehicles. Guaranteed income options add another layer of complexity to an already daunting job. Sponsors must evaluate insurance providers for financial stability, assessing their ability to pay benefits 20+ years into the future. Typically the costs of an annuity are not outlined like an expense ratio; they are charged as a reduction in the interest rate credited to the account. Quantifying and disclosing these costs is a complex, time-consuming exercise. And according to research from Callan Associates (Callan), 71% of plan sponsors are already very/somewhat concerned about plan costs, even without the expense of guaranteed income features. Callan s 2017 research in the DC plan market revealed that 87.5% of plan sponsors are very likely to not offer any type of guaranteed income over the next year. According to the survey, the top five reasons include: unnecessary or not a priority; uncomfortable/unclear about fiduciary implications; too costly to plan sponsors/participants; no participant need or demand; and concerned about insurer risk. 6 EBRI Issue Brief December 2013. No. 394. Page 4 of 7
We believe that the primary reason is important. DC plan sponsors are choosing to prioritize their time where it may best improve retirement outcomes, rather than developing solutions they don t think participants need. Spending time focusing on decumulation solutions is important for plan sponsors as they look at managing their workforce and maintaining cost-effective plans. From the participant perspective, as employees age, they tend to be more focused on retirement benefits. Exhibit 6 shows the percentage of workers who view a company s retirement program as a key driver to whether they stay with their existing employer. It also highlights the percentage of job seekers who consider these programs key when considering a new job opportunity. Exhibit 6: Attraction and Retention Value of Retirement Programs 60% 50% 40% 30% 20% 10% 0% Attraction Retention 25 37 Source: Towers Watson 2013/2014 Global Benefit Attitudes Survey U.S. As of 5/28/14. Keeping Retiree Assets in a Retirement Plan May Offer Benefits to Everyone 31 < 40 40-49 Age Range 50+ By remaining in-plan after retirement, severed/retired employees can take advantage of the scale of an employer s 401(k) to invest more cost effectively, and potentially gain access to customized decumulation vehicles. Currently most retirees leave their employer s DC plans at retirement or shortly thereafter. Participants retiring between 2008 and 2010 kept 69% of assets in their 401(k) plan. 7 But assets remaining in-plan do not typically stay there very long: the average participant withdraws more than 20% of the account balance annually at, or soon after, retirement, and only 17% of participants remain in the plan three years after retirement. 8 These assets departing have a large impact on the overall plan costs as often these retiring employees have larger account balances. Typically, recordkeeping fees have an inverse relationship to the average account balance; as the plan s average account balances decrease through retirees withdrawals, the plan s recordkeeping fees increase. For some plans that are offering 46 33 53 vehicles other than mutual funds, the sliding fee scale of these vehicles (separate accounts or collective investment trusts) also offers lower fees to all participants if the assets are higher. Participants can benefit from staying in the 401(k) plan. It has been widely reported that higher management fees after a rollover can negatively impact retirees. According to Morningstar, the median moderate retail balanced mutual fund fee is 1.6%, compared to the median 401(k) fee of 0.78%, with the 10th percentile being 0.28% and the 90th percentile being 1.38%. 9 As shown in Exhibit 7, the impact on retiree portfolios can be dramatic. Exhibit 7: Economic Benefit of Lower Fees Fee Differential Dollar Impact on $75,000 Account Over Retirement Dollar Impact on $100,000 Account Over Retirement Years of Savings Lost to Higher Fees 25 bps $17,400 $23,200 3.9 50 bps $33,700 $44,900 7.5 75 bps $48,800 $65,100 10.9 100 bps $62,900 $83,900 14.0 Assumes $75,000 and $100,000 beginning balances over 30-year time periods. Callan has reported that only 28.3% of plan sponsors seek to retain retiree assets. 10 But while most DC plan sponsors are not actively trying to retain retiree assets, some are making the effort, and as a selling point they are promoting lower fees and a broader selection of investment options and vehicles than participants are able to access on their own. New FINRA regulations could also change the rollover landscape, potentially leading to higher in-plan asset retention. In early 2014, FINRA issued a warning to member firms that they should not be recommending separating employees rollover money from the company s 401(k) plan into an IRA, if it would be more beneficial to leave that money in the company s plan, or transfer it to a new employer s plan. Such guidance could contribute to declining rollovers into broker/dealer and recordkeeper IRAs and higher DC plan asset retention post-retirement. If the industry and employers want to maintain assets in retirement plans, we need to focus on offering more dedicated decumulation strategies that take into account differing needs in retirement, unique spending patterns, growth and liquidity. 7 EBRI May 2014. Vol. 35 No.5. 8 Analysis by JP Morgan Asset Management as featured in Janus 1Q 2013 DC in Review Guide. 9 Morningstar Direct data. As of 6/30/14. 10 Callan 2017 Defined Contribution Trends Survey. Page 5 of 7
DOL Income Illustrations Highlight the Potential Income from DC Account Balances The U.S. Department of Labor (DOL) is making income illustrations a priority with a goal of giving DC plan participants some idea of the level of income their savings would generate if it were delivered as an annuity stream. But while these new illustrations may help younger participants and other accumulators, they are proving to be of limited use for those most at risk for retirement income shortfalls: today s pre-retirees. First, lifetime income illustrations assume that contributions increase at 3% a year, which is at the cutting edge of today s DC plan design. Few pre-retirees have had the benefit of such plan features throughout their lifetime. And few will have sufficient time or inclination to take advantage of them between now and their expected retirement date e.g., plan sponsors have trouble enrolling current participants in auto-escalation features at all, even ones that only increase 1% per year. Likewise, some projections use no contribution cap, allowing contributions to grow to the maximum IRS limit. In reality very few participants reach that level. Lifetime income projections also assume a 7% aggregate investment return. While equity markets have performed well the past few years, the average DC plan participants earned just 4.1% over the past 10 years ending in 2014, according to the DOL. And factor in current low global growth combined with rising interest rates, and that could further dampen returns for pre-retirees who most need asset growth to make up for insufficient balances. Finally, few DC plan participants respond to lifetime income illustrations with positive behavior changes even when their projected income is much less than expected. For plan participants whose illustrated income was much less or somewhat less than expected, only about one-third (35%) indicated they would increase their contributions. 11 For those whose illustrated income was what they expected, only 10% would increase their contributions. It is important here to note that what they expected does not mean adequate retirement income. In a 2014 benchmarking survey conducted by Deloitte, only 12% of plan sponsors reported that most employees are, or will be, financially prepared for retirement. 12 While the study acknowledges that average account balances are increasing, the not-so-good news is that it would be difficult for anyone to remain financially viable in retirement on $85,000, especially with the questionable promise of Social Security in the future. So when participants say that their lifetime income projection is about what they expected, that does not mean that the projected income is adequate to cover their needs. Moreover, the majority of those who indicated they would increase their savings rate said they would do so by a mere 10%. Only about 11% of those increasing their contributions would raise them by 50% or more. This data emphasizes the importance of providing options that give these participants the opportunity to have continued asset growth in retirement. How Do We Shift the Focus? We believe that the most beneficial approach to the retirement income challenge is to shift our focus from guaranteed income to focused decumulation strategies designed for retirement. Such vehicles could deliver an economic benefit to the plan by retaining assets and increasing economies of scale. And they could benefit a growing generation of retirees regardless of the size of their account balances. Decumulation strategies may deliver growth and flexible income to participants who face potentially significant shortfalls in retirement income and have resisted locking up their assets in guaranteed income vehicles. New accumulation vehicles e.g., target date and other types of multiasset vehicles are truly revolutionary. But while they are proving successful in solving some of the accumulation challenge, asset managers and plan sponsors face a new and growing challenge on the decumulation side. Retirees with chronically low account balances need asset growth during retirement, combined with sufficient income flexibility to address changing spending needs throughout retirement. We believe that the asset management industry could deliver effective solutions by designing multi-asset vehicles geared specifically for decumulation placing greater emphasis on volatility managed strategies, defensive equities, tail-hedging and diversified inflation protection strategies. Such vehicles would differ from accumulation vehicles that merely shift their allocations among existing asset classes once a participant reaches retirement. Accumulation vehicles also rely heavily on the equity risk premium for growth, without re-thinking the kinds of assets that may be appropriate for the specific risks and needs faced by retirees especially the need for downside protection. The benefits to participants of customized decumulation vehicles include greater flexibility, lower fees and a chance of having assets participate in the markets during the decumulation years. The benefits to plan sponsors include a greater ability to meet the needs of a changing workforce and lower overall plan costs. We also believe that customized decumulation solutions for retirees could address the issues that are hampering the development and rollout of guaranteed income. 11 EBRI.org, Notes, March 2014, Vol. 35, No. 3. 12 Deloitte Annual 401(k) Benchmarking Survey. 2014 Edition. 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