NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE Retirement reset How re-enrollment can help strengthen U.S. retirement security AUTHORS Anne Lester Portfolio Manager and Head of Retirement Solutions IN BRIEF Ten years after the passage of the Pension Protection Act (PPA), the U.S. retirement system still fails too many, too often. A critical problem is inappropriate asset allocation by defined contribution (DC) plan participants. A plan re-enrollment is one action plan sponsors can take that can immediately help move the needle toward better retirement outcomes for plan participants. Participant assets are often defaulted into a professionally managed, well-diversified investment option, such as a target date fund (TDF). Participants are then less inclined than other fund investors to move their assets at inopportune times. For plan sponsors, a re-enrollment can bolster confidence that participants are on a sensible investing path and have a decent chance of staying on the path. Re-enrollment may also provide stronger protection from investing liability. Widespread misperceptions about re-enrollment mean that only 7% of all plans have implemented the strategy. We urge all plan sponsors to work with their financial advisors/ consultants and legal advisors to consider its substantial benefits. John Galateria Head of North America Institutional
RETIREMENT RESET: HOW RE-ENROLLMENT CAN HELP STRENGTHEN U.S. RETIREMENT SECURITY AUGUST 2016 MARKS THE TENTH ANNIVERSARY OF THE PENSION PROTECTION ACT (PPA), transformational legislation that aimed to bolster the U.S. retirement system. The law made great strides, creating new opportunities for stronger DC plans and greater potential for increased retirement security. But a harsh reality cannot be ignored: The U.S. retirement system is still falling short. Many Americans remain woefully unprepared for a retirement that may last upwards of 30 years. Although progress has been made on the savings front, advances have been far more limited in getting participant assets allocated appropriately. One potent tool can help solve that problem a re-enrollment. This process enables plan sponsors to encourage plan participants to reset investment strategies in ways that can help get participants on a better investing path, leading to more successful retirement outcomes. In a re-enrollment, participants are notified that their existing plan assets and future contributions will be invested in the plan s qualified default investment alternative (QDIA), as defined in Employee Retirement Income Security Act (ERISA) regulations, on a certain date unless a participant makes a new investment election during a specified time period. In the following pages, we describe the particular power of re-enrollment and address the misperceptions that have restrained employers from using the strategy. Let us speak plainly. Re-enrollment is one action plan sponsors can take that can immediately help move the needle toward better retirement outcomes for plan participants. We call on the entire industry plan sponsors, financial advisors/consultants, recordkeepers to carefully evaluate the benefits of this strategy. Re-enrollment is one action plan sponsors can take that can immediately help move the needle toward better retirement outcomes for plan participants. THE PPA SET A STRONG FOUNDATION As we assess the state of the U.S. retirement system a decade after the PPA took effect, we first acknowledge that the law set a very solid foundation. First, it established a legal framework for the use of automatic enrollment, which helps to quickly improve participation rates in many employer-sponsored plans. The PPA also made possible the use of automatic contribution escalation, which helps participants automatically increase savings rates to reach a more suitable level. Finally, the PPA tackled an essential problem of DC plans the inappropriate investment of participant assets through the introduction of a new plan element, the QDIA. The two plan design features, automatic enrollment and automatic contribution escalation, address the essential first step to retirement security: saving. Across a wide range of geographic regions and income levels, many Americans are not saving enough saving early enough saving at all In automatic enrollment, after proper notification has been given, and certain other conditions are met, employees are enrolled in a plan unless they explicitly opt out. Though the practice predates the PPA, the law identified safe harbors for plan sponsors that use automatic enrollment. It also eliminated a potential obstacle by making it clear that federal law, ERISA, preempts any state law that required employees affirmative consent for payroll deductions. Although the PPA encouraged the wider adoption of automatic enrollment, the statute did not specify what a default contribution rate should be. The majority of plan sponsors use a 3% default rate, according to a Plan Sponsor Council of America (PSCA) survey published in 2015. We believe that rate is much too low for many employees. The PPA also endorsed another feature, automatic contribution escalation, which automates annual increases in participant savings rates (here, too, participants can opt out). The two programs, automatic enrollment and automatic contribution escalation, should go hand in hand but often they do not. Defined Contribution Institutional Investment Association s (DCIIA) 2015 research finds that more than 60% of large plans and 45% of all plans have incorporated automatic enrollment, but less than one-half of large plans and one-third of all plans have implemented automatic contribution escalation. Automatic 2 RETIREMENT INSIGHTS
RETIREMENT RESET: HOW RE-ENROLLMENT CAN HELP STRENGTHEN U.S. RETIREMENT SECURITY enrollment on its own may be limiting if it freezes plan participants at too-low contribution rates. In addition, automatic contribution escalation is often offered as an option employees must voluntarily choose to adopt. This suggests that the percentage of participants using the plan feature is significantly lower than the percentage of employers that have adopted it. We recommend that plan sponsors consider an opt-out approach, rather than an opt-in approach, when they introduce automatic contribution escalation. THE PPA BREAKS NEW GROUND: PROFESSIONAL ASSET ALLOCATION AND THE QDIA Clearly, saving and investing are the two forces driving the relative success of a retirement outcome. But although plan sponsors ultimately have little influence over how much participants save (the auto programs help, but they can only go so far), plan sponsors can help participants on the vital fronts of investing and asset allocation. Of course, saving is a critical determinant of a retirement outcome the math is undeniable. But investing, and in particular asset allocation, are also extremely important. This principle defined one of the main accomplishments of the PPA: It helped to repair less than optimal participant asset allocation in DC plans. Prior to the PPA, the default investment in most plans was either stable value funds or money market funds. As a result, many participants ended up in these funds and stayed there for years, leaving them with inappropriate, and sometimes extremely inappropriate, asset allocation for their age and risk profile (see When the safe course is anything but ). Under certain conditions, the PPA gave plan sponsors protection from liability when participant contributions typically made through automatic enrollment are defaulted into a qualified default investment alternative if those participants failed to make an affirmative investment decision. In general, this protection is available to a plan sponsor that prudently selects the QDIA, properly informs employees about the process, and finally and critically makes sure participants are given the chance to make their own investment choices from the plan s menu. In other words, either participants select an investment option for their plan contributions, or they do not make a selection and are consequently defaulted into a QDIA. WHEN THE SAFE COURSE IS ANYTHING BUT It is important not to underestimate the damage that can be caused by inappropriate asset allocation by DC plan participants. Evidence of this theme and affirmation of the power of diversification in a retirement portfolio can be seen in analysis presented by Anne Lester, Head of Retirement Solutions, J.P. Morgan Asset Management, at a government hearing on target date funds in June 2009. The analysis compared hypothetical results of someone who had invested in a simulated TDF for 25 years whose portfolio would have lost more than 20% of its assets in 2008 with someone invested in the safe alternative: a money market fund.* The simulated TDF portfolio generated almost double the assets, even after the 20% loss in 2008 and 10 years of essentially no returns from the U.S. equity market. Put another way, the person in the money market fund would have had to save more than twice as much to end up in the same place. * TDF returns are modeled using index returns for each asset class, with allocations that change in accordance with an allocation that starts with a JPMorgan 2030 TDF strategy allocation and glides for 25 years to end in the Income fund in February 2009. Cash returns were simulated using T-bills. The hypothetical analysis is shown for illustrative purposes only and is not intended to be reflective of a specific J.P. Morgan target date fund. The element of default is critical. It draws on the force of human inertia, and this is one of its most powerful attributes. Presented with an opportunity to make a choice, people often do nothing. As Harvard Law School professor and Nudge co-author Cass Sunstein has written, default rules incline people s choices in a particular direction [they] have a large impact, because they tend to stick. 1 For all these reasons, use of a prudently selected QDIA gives plan sponsors their greatest opportunity to ensure that employees who do not choose to make an investment election can still be invested appropriately for their age and risk profile. It fairly quickly changed the way participants invest in 401(k) plans. What is the best investment vehicle for a plan s QDIA? As we explain below, we believe it is the professionally managed, well-diversified, multi-asset class solution known as a target date fund that meets the requirements of the QDIA regulation. 1 Cass R. Sunstein, Deciding by default, University of Pennsylvania Law Review. Vol. 162, No. 1, 2013: 5. J.P. MORGAN ASSET MANAGEMENT 3
RETIREMENT RESET: HOW RE-ENROLLMENT CAN HELP STRENGTHEN U.S. RETIREMENT SECURITY KEY BENEFITS OF A RE-ENROLLMENT FOR PARTICIPANTS Potential for improved asset allocation Potential for better investment performance Help for new and existing participants Less emotion in investing when plan QDIA is a target date fund FOR PLAN SPONSORS Potentially stronger protection from investing liability Greater confidence employees will stay on track to a successful retirement outcome Enhanced ability to focus on helping employees with the educational basics of saving and financial planning Many plan sponsors and plan participants would agree. TDFs accounted for 15.3% of DC plan assets in 2014, up from 2.3% in 2005, the year before passage of the PPA. According to Callan Associates, in the fourth quarter of 2015, TDFs accounted for more than 80% of net flows into 401(k)s. RE-ENROLLMENT: INVESTING RESET AND THE POWER OF HUMAN INERTIA Not long after the PPA was enacted and the Department of Labor finalized its QDIA rules, asset managers, financial advisors/consultants and plan sponsors began to think about how to use the QDIA to tackle the critical issue of poor asset allocation for employees who were already enrolled in a DC plan. The strategy they developed was the investing reset known as re-enrollment. The process enables plan sponsors to do for existing plan participants what automatic enrollment allowed them to do for new participants ensure that they would be able to quickly start on a solid investing path with appropriate asset allocation. Plan sponsors are responsible not just for investments but for investing. Fred Reish, Partner, Employee Benefits & Executive Compensation Practice Group, Drinker Biddle & Reath LLP In many ways, re-enrollment is the logical next step on a journey that began with the passage of the PPA. After the PPA led to improvements in DC participant asset allocation through the use of the QDIA, re-enrollment allowed the process to happen with relative speed and with the potential for strong fiduciary protection for plan sponsors. It put all plan participants on equally strong footing regarding their overall asset allocation. We believe that for both participants and plan sponsors, re-enrollment offers clear, tangible benefits. This strategy quickly improves asset allocation for many participants, especially when the plan s QDIA is a target date fund. Because participants are defaulted into a TDF based on their age, the asset allocation reflects their investment time horizon, while the fund s glide path, which changes with a participant s age, determines the appropriate mix of assets. Moreover, target date funds take much of the emotion out of investing for DC plan participants. Once participants are invested in a TDF, they tend to stay the course and are less inclined than other fund investors to move their assets at inopportune times. As a result, TDF investors overall may have a better investing experience than investors in non-tdfs, who more often buy high and sell low. According to a Morningstar report that analyzed 10 years of target date fund data through December 31, 2014, asset-weighted investor returns which account for flows into and out of the fund to estimate a typical investor s experience are 1.1 percentage points higher than the fund s total return, which assumes an investor follows a buy-and-hold strategy over the 10-year period. For all fund categories, the gap between the fund s average 10-year total return and the lower, asset-weighted 10-year investor return is 0.54%. From the perspective of a plan sponsor, re-enrollment can bolster confidence that participants are on a sensible investing 4 RETIREMENT INSIGHTS
RETIREMENT RESET: HOW RE-ENROLLMENT CAN HELP STRENGTHEN U.S. RETIREMENT SECURITY path and have a decent chance of staying on the path to a successful retirement outcome. Says Fred Reish, a partner in the Employee Benefits & Executive Compensation Practice Group at Drinker Biddle & Reath LLP, Plan sponsors are responsible not just for investments but for investing. For plan sponsors, a re-enrollment may provide stronger protection from investing liability. If their default programs satisfy certain requirements, plan sponsors may gain safe harbor protection for assets defaulted into a QDIA. Re enrollment encourages plan sponsors to help plan participants focus on the risks they can control, and this is a key reason the strategy is so effective. As we see it, the industry has invested far too much time and too many resources trying to educate employees to become investors that is, to deal with something the market that is fundamentally beyond their control. Participants are much better served when plan sponsors educate their employees to concentrate on risks they can completely or partially control (savings vs. spending, employment earnings and duration) and leave it to the professionals to manage market risk (EXHIBIT 1). Unencumbered by the need to teach their employees how to become investors, plan sponsors can focus on helping employees with the critical educational basics of saving and financial planning. Some plan sponsors assume that re-enrollment is a very cumbersome process. But the requisite technology is readily available. And once the strategy has been implemented, the impact is immediate. For example, employers that add TDFs without a re-enrollment typically find that TDFs attract an average 1% 4% of plan assets; plans that go through a re-enrollment see 49% to 97% of plan assets in TDFs (EXHIBIT 2). Implementation strategy of TDFs matters. A re-enrollment can dramatically increase TDF utilization rates EXHIBIT 2: TDF UTILIZATION RATES 1 % TO 4 % TDF UTILIZATION RATES (as % of plan assets) 49 % TO 97 % Plan sponsors should educate their employees to concentrate on risks they can completely or partially control and leave it to the professionals to manage market risk EXHIBIT 1: THE RETIREMENT EQUATION Add-to-menu Source: J.P. Morgan retirement research 2015. Re-enrollment TOTAL CONTROL Saving vs. spending Employment earning and duration Asset allocation and location RETIREMENT Market returns Policy regarding taxation, savings and benefits OUT OF YOUR CONTROL To implement a re-enrollment effectively and efficiently, plan sponsors should work with their plan provider or recordkeeper to define the procedures and time line. Most recordkeepers have a robust process in place to ensure that re-enrollment is as smooth as possible. But we emphasize that for plan sponsors, first principles should take precedence over process. An employer should first determine the needs of its DC plan and evaluate which design features and investment structures would be most likely to meet those needs. A plan sponsor should then find the provider that can best help to realize those goals. Longevity SOME CONTROL Source: Retirement savings: The importance of being earnest, J.P. Morgan Asset Management, 2013. J.P. MORGAN ASSET MANAGEMENT 5
RETIREMENT RESET: HOW RE-ENROLLMENT CAN HELP STRENGTHEN U.S. RETIREMENT SECURITY Participants making their own asset allocation choices often have too much or not enough equity exposure EXHIBIT 3: DO-IT-YOURSELFERS EQUITY POSITIONS VS. J.P. MORGAN SMARTRETIREMENT GLIDE PATH Do-it-yourselfers equity allocation 10% under J.P. Morgan glide path 10% over J.P. Morgan glide path 100 Older workers holding too much equity are putting their retirement savings at risk because of increased market volatility. Percent in equity 80 Younger workers who are too conservatively invested may forgo potential returns in years when their money could be working harder for them. 60 40 20 0 20 25 30 35 40 45 Age 50 55 60 65 70 Source: J.P. Morgan retirement research. Representative sampling of 3,000 do-it-yourself participants; data as of December 31, 2015. Shown for illustrative purposes only. MISPERCEPTIONS ABOUT RE-ENROLLMENT THE PATH FORWARD Despite all the benefits of re-enrollment, only 7% of all plans have implemented the strategy. We believe that some misperceptions, as well as lack of awareness, may be slowing its adoption. According to our 2015 Defined Contribution Plan Sponsor Research: As we look back at the 10 years since the PPA was enacted, it is clear that the law set the industry on a path toward better retirement outcomes. Re-enrollment is an important part of that journey. 54% of plan sponsors were not aware of the potential to receive fiduciary protection for assets defaulted into a QDIA during a re-enrollment. 28% of plan sponsors did not consider conducting a re-enrollment because they were comfortable with the plan s aggregate asset allocation. But the aggregate plan allocation may bear no resemblance to participant allocation. Example: At the individual level, 80% of participants fall outside a range of appropriate equity exposure for their age (EXHIBIT 3 ). 44% of plan sponsors considered but did not conduct a re-enrollment; the primary deterrent was fear of employee pushback. But 60% of participants said they would rather let an expert manage their account.2 Clearly, the industry can do a much better job of keeping re-enrollment front-and-center in their conversations with plan sponsors. The good news is that more plan sponsors are thinking about it. Our 2015 Defined Contribution Plan Sponsor Research found that 53% of respondents have either considered or conducted a re-enrollment, up from 39% in 2013. 2 6 J.P. Morgan Plan Participant Research 2016. R ET IR EMEN T IN S IG H TS We are pleased to see that a growing number of asset managers have become strong public advocates of re-enrollment. We urge all plan sponsors, regardless of their chosen asset manager or recordkeeper, to work with their financial advisors/ consultants and legal advisors to actively consider how re-enrollment can bolster their DC plans and may give their employees a better chance of a successful retirement. We know that the U.S. retirement system still fails too many, too often. Finally, though, we are optimistic. We have every confidence that as the adoption of re-enrollment continues to increase as the industry harnesses the full power of this proven strategy it will go a long way toward strengthening retirement security for millions of American workers.
TO LEARN MORE ABOUT THE BENEFITS OF RE-ENROLLMENT OR FOR ADDITIONAL RE-ENROLLMENT RESOURCES, CONTACT YOUR J.P. MORGAN REPRESENTATIVE J.P. MORGAN ASSET MANAGEMENT 7
RETIREMENT INSIGHTS J.P. MORGAN ASSET MANAGEMENT 270 Park Avenue I New York, NY 10017 J.P. Morgan Asset Management cannot provide legal or tax advice to any Plan Sponsor. Plan Sponsors are advised to consult with their own legal and other professional advisors before making a decision to implement plan re-enrollment. TARGET DATE FUNDS: Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis, with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date. IMPORTANT DISCLOSURES FOR SCATTERPLOT CHART METHODOLOGY: Do-it-yourselfers are participants with less than 70% of their account balance invested in target date funds as of the day of the measurement period and also includes participants using online advice services, if applicable. The analysis excludes self-directed brokerage and managed account users. Contact JPMorgan Distribution Services at 1-800-480-4111 for a fund prospectus. You can also visit us at www.jpmorganfunds.com. Investors should carefully consider the investment objectives and risks as well as charges and expenses of the mutual fund before investing. The prospectus contains this and other information about the mutual fund. Read the prospectus carefully before investing. Opinions and estimates offered constitute our judgment, are not specific to any particular plan and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. J.P. Morgan Funds are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of JPMorgan Chase & Co. receive fees for providing various services to the funds. JPMorgan Distribution Services, Inc. is a member of FINRA/SIPC. J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited to, JPMorgan Chase Bank N.A., J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc. Copyright 2016 JPMorgan Chase & Co. April 2016 RI_Retirement reset