Addressing Retirement Readiness

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The past 30 years has born witness to the collapse of the private pension system with for-profit employers, tax-exempt entities and now the governmental sponsors replacing defined benefit pension …

The past 30 years has born witness to the collapse of the private pension system with for-profit employers, tax-exempt entities and now the governmental sponsors replacing defined benefit pension programs with defined contribution plans. This practice spawned a well-documented transfer of investment and funding risk from employer to employee. Now, most defined contribution plans render the employee the sole decision maker on the four factors that determine an employee's ability to retire successfully: contribution rate, investment strategy/return, time horizon, and spending needs in retirement.<br /><br /> In this presentation we will address what employers can do to help employees meet the demands of the new retirement plan era.

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  • 70% of Public Plans and 40% of Private Plans have a Mandatory Employee Contribution
  • 70% of Public Plans and 40% of Private Plans have a Mandatory Employee Contribution
  • Fidelity Survey of participants indicated 29% would not do so again
  • 70% of Public Plans and 40% of Private Plans have a Mandatory Employee Contribution


  • 1. ©2003 – 2013 Multnomah Group, Inc. All Rights Reserved.Addressing Retirement ReadinessMaking Defined Contribution Plans Work
  • 2. Erik Daley, CFAADDRESSING RETIREMENT READINESS2Erik is the Managing Principal for Multnomah Group. He is a member ofMultnomah Group’s Investment Committee and leads the firm’s tax-exemptpractice, focusing on higher education and healthcare organizations. Erikconsults regularly with clients on a variety of retirement plan related topics tohelp manage their fiduciary risks. He is a national speaker on retirement planissues.Prior to founding the Multnomah Group in 2003, Erik served as a VicePresident of Retirement Services and led the Portland, OR practice of anational retirement services firm. In that position Erik was a founding memberof the firm’s national Investment Committee and had oversight for businessdevelopment in the western United States.Erik is a member of the CFA Institute, the CFA Society of Portland, the CFASociety of Seattle, the American Society of Pension Professionals andActuaries, the Portland Chapter of the Western Pension & BenefitsCouncil, and the Society for Human Resource Management. Erik holds aB.B.A. from the University of Iowa.
  • 3. AgendaADDRESSING RETIREMENT READINESS3• Introduction• Retirement Readiness• Defined Contribution Plan Lifecycle• Plan Design• Young Savers• Accumulators• Pre-Retirees• Plan Services• Investment Structures• Employee Education Needs• 5 Steps to Creating a True Retirement Plan
  • 4. The World has ChangedADDRESSING RETIREMENT READINESS4• Defined Benefit pension plans arerapidly becoming extinct• For-profit• 501(c)3• Governmental• Causes• Portability• Accounting requirements• Actuarial standards• Funding volatility• Consequences• Risk transferSource: U.S. Social Security Administration, Office of Retirement andDisability Policy, “The Disappearing Defined Benefit Pension and itsPotential Impact on the Retirement Income of Baby Boomers.”
  • 5. Change in Model for Retirement SavingsADDRESSING RETIREMENT READINESS5Defined Benefit Plans Defined Contribution PlansPrimarily employer funded, withoccasional required participantcontributionsFundingMix of employer and employeecontributionsEmployer directed Investment Strategy Participant directedParticipants determine how much incomethey need to replace and work to the goalof achieving that level of benefitEvaluation MetricParticipants focus on generating a sum ofassets that will become the source ofmeeting retirement expensesHigh Plan Sponsor Volatility LowParticipants are protected againstinvestment and longevity riskParticipant “Safety”Each participant must individually ensuretheir retirement preparedness1National Institute on Retirement Security. Retirement Readiness – WhatDifference Does a Pension Make?85% Retirement Readiness151% Retirement Readiness1
  • 6. Retirement Readiness in a Defined ContributionWorldADDRESSING RETIREMENT READINESS6Contribution Rate Investment Return Time HorizonRetirement IncomeNeedsParticipantApproachEmployers determine thecontributions they makeinto participant accounts,but for the vast majorityof defined contributionplans, thosecontributions need to beaugmented by employeedeferrals andsupplemental savings. Aparticipant’ssupplementalcontribution rate is acritical element in therate of success inretirement savings.Participants in definedcontribution plans selectinvestments thatultimately determine therate of return achievedon their savings and anycontributions made bytheir employer.DC plans have very littlecontrol over when aparticipant elects toretire. Plans arestructured to permitparticipants to continuesaving on a tax-deferredbasis until they elect toretire or are terminatedby their employer. Someparticipants may beincented to continueworking past age 70 ½ toavoid IRS MinimumRequired Distributions.The degree to whichsavers have managedexpenses well in theiraccumulation phase willimpact their ability andwillingness to retire.Eligibility for healthbenefits and fixedmortgage costs aresignificant variables indetermining aparticipants incomeneeds.Challenge Current Moment Bias Gambler’s Fallacy Status Quo Bias Negativity Bias
  • 7. Impact of the TransitionADDRESSING RETIREMENT READINESS7Employees whose primary retirement plan is a DC plan tend to retire one to twoyears later than employees covered by a pension plan.Center for Retirement Research, “The Recent Trend Towards Later Retirement,” March 2007Individuals covered only by a DB plan are 87% more likely to retire in any givenyear that individuals only covered by a DC plan.Rui Yao and Eric Park, University of Missouri, “Do Market Returns Affect Retirement Timing?” 2011A 1% increase in the S&P 500 Index in any given year increases the probabilitythat the pre-retiree will retire by 2.5%.Rui Yao and Eric Park, University of Missouri, “Do Market Returns Affect Retirement Timing?” 2011By 2020, 20% of the workforce is projected to be 65 and older. The onlyprojected growth in the labor force for 2020 will be in employees 55 and older.Bureau of Labor StatisticsThe ability to retain young talent is impacted by the prospect of career andprofessional advancement.
  • 8. Costs are RealADDRESSING RETIREMENT READINESS8Workers’ compensation claim duration is 25% longer and benefit payments are56% higher.PLANSPONSOR.comDisability premiums are 15 times higher and disability instances are 42%among workers ages 65 and older.PLANSPONSOR.comDelayed retirements may also increase employers’ healthcare costs.Healthcare costs for a 65-year-old worker are twice those of a worker betweenthe ages of 45 and 54.U.S. Department of Health and Human Services, “National Health Care Expenditure Sheet.” Data as of 2004
  • 9. Retirement ReadinessADDRESSING RETIREMENT READINESS9The state and/or degree of being ready for retirement. Retirement readinesstypically refers to being financially prepared for retirement, or the degree towhich an individual is on target to meet his or her retirement-income goals sothat the standard of living enjoyed while working will be maintained afterretirement.• Viewing defined contribution through the prism of retirement income benefits• Defined contribution retirement readiness is dramatically impacted by thesteps employees have taken prior to their current employment
  • 10. Lifecycle of a Defined Contribution PlanADDRESSING RETIREMENT READINESS10•Young•Lower income•Directcompetition forearned incomeYoung Savers•Mid career•Highlyproductive•FinanciallysecureAccumulators•Accomplished•Experienced•Concludedcosts ofestablishing afamily / lifePre-Retirees1. Begin the retirement savingsprocess2. Reward engagement andpatience3. Affirm the commitment tobeginning the savings process1. Demonstrate the progresstowards retirement readiness2. Reduce the impact of leakage onretirement readiness3. Begin educating on whatretirement is1. Provide extensive access tofinancial planning and advice2. Focus on retirement plan as a toolfor securing retirement rather thana wealth accumulation instrument3. Identify opportunities to incentretirement
  • 11. Designing the Best Defined Contribution PlanADDRESSING RETIREMENT READINESS11Plan Forward1. Benefit Plan Design2. Plan Provider Services3. Investment Structures4. Participant Education
  • 12. Benefit Plan Design – Young SaversADDRESSING RETIREMENT READINESS12Young SaversAccumulatorsPre-RetireesNearly all defined contribution plans require an employee todefer salary to derive adequate retirement benefits• A general rule of thumb is 10-15% total to generate adequateincome replacement1. Employee Mandatory Contributions2. Automatic Enrollment and Automatic Escalation3. Adopting a Hybrid Match Formula
  • 13. Benefit Plan Design – Young SaversADDRESSING RETIREMENT READINESS13Automatic Enrollment and AutomaticEscalationAdopting a Hybrid Match FormulaPros Fundamentally does not change the “contract”between participant and plan sponsor. Planparticipants are provided an option to opt-outbased on their needs, but many participantselect to remain automatically enrolled andthereby become participants.In some instances, a hybrid match formula mayreduce the cost of contributions by the sponsor.Participants may be incented to “engage” in theirretirement planning process.Cons While automatic enrollment can be instituted insuch a way to address current employees whoare not deferring, it is most typical to beginautomatic enrollment prospectively, therebyreducing its potential impact on currentparticipants.Impact of the change may not be as significantas the political cost of adopting. Further, thelowest paid employees will likely see theirretirement preparedness decline, which may notmeet the social justice policies of the sponsor.Implementation Relatively easy. Employees surveyed generallysupport the implementation of automaticenrollment, especially when it does not impactthem. Older payroll systems can be challengingto customize in a manner supportive ofautomatic increase and enrollment features.Difficult. Taking current contributions made bythe sponsor and making them contingent is seenas a takeaway; even in instances where thepotential contribution grows.
  • 14. Automatic Feature Implementation FrequencyADDRESSING RETIREMENT READINESS14Automatic EnrollmentAnnual IncreaseProgramHigher Education <5% <5%Not-for-Profit Healthcare 29% 49%Corporate 22% 76%1Plan Design in Higher Education: Best Practices for Improving Retirement Readiness
  • 15. Automatic Enrollment WorksADDRESSING RETIREMENT READINESS1554%83%0%10%20%30%40%50%60%70%80%90%Non-AE Plan Participation Rate AE Plan Participation RateThe Impact of Automatic Enrollment on Participation Ratesin Corporate DC Plan11Plan Design in Higher Education: Best Practices for Improving Retirement Readiness
  • 16. Benefit Plan Design – AccumulatorsADDRESSING RETIREMENT READINESS16Young SaversAccumulatorsPre-Retirees“Neither a borrower or a lender be”1. Plan Rollovers2. Retirement Plan Loans3. Hardship Withdrawals
  • 17. Retirement LeakageADDRESSING RETIREMENT READINESS17Only 20% of employees who take a lump-sum distribution roll proceeds into atax-qualified IRA or retirement plan accountGAOParticipants age 35-45 are more likely to borrow – and when they do, are morelikely to take the maximum – as compared to their younger and oldercounterpartsBorrowing from Yourself: The Determinants of 401(k) Loan PatternsEstimated participant loan default rate from July 2011 – May 2012 was 17.4%Navigant EconomicsPrevailing plan interest rate is tied to Prime (3.25%)Hardship distributions are much less prevalent (typically less than 2% annually)
  • 18. Defined Contribution Plan Participants’ ActivitiesADDRESSING RETIREMENT READINESS182006 2007 2008 2009 2010 2011% of Active Participants with aLoan15.0% 16.0% 15.3% 16.5% 18.2% 18.5%US Retirement Assets in DefinedContribution Plans ($trillion)$4.1 $4.4 $3.4 $4.0 $4.5 $4.615.0%16.0%15.3%16.5%18.2%18.5%0.0%2.0%4.0%6.0%8.0%10.0%12.0%14.0%16.0%18.0%20.0%2006 2007 2008 2009 2010 2011% of Active Participants with a LoanInvestment Company Institute, Defined Contribution Plan Participants’Activities 2011, April 2012
  • 19. Benefit Plan Design – Pre-RetireesADDRESSING RETIREMENT READINESS19Young SaversAccumulatorsPre-RetireesHelp participants keep their eyes on the prize1. In-service plan distributions2. Early retirement windows
  • 20. In-Service Plan DistributionsADDRESSING RETIREMENT READINESS20Plans routinely provide older employees (59 ½ - 65) the ability to begin takingdistributions from their retirement plan1. Maintain a focus on retirement2. In-service distributions should ideally be tied to phased retirement programswith committed dates of retirement
  • 21. Plan ServicesADDRESSING RETIREMENT READINESS21• K.I.S.S. your participants• Easy to enroll• Easy to allocate• Easy to use• Sophisticates will optimizeoutcomes in any plan designParticipant Type HowParticipantsSelf-IdentifyDelegators 69%Do-It-Yourselfers 30%Self-Directed Sophisticates 1%Source: J.P. Morgan Retirement Plan ServicesImpact of Choice on Participation RatesSource: Iyengar, Sheena S.; Jiang, Wei; Huberman, Gur “How Much Choice is Too Much?:Contributions to 401(k) Retirement Plans”
  • 22. ADDRESSING RETIREMENT READINESS22Investors Fail to Track the Market3.83%9.14%1.01%6.89%2.57%0.00%1.00%2.00%3.00%4.00%5.00%6.00%7.00%8.00%9.00%10.00%Avg. Equity Investor S&P 500 Index Avg. Fixed Income InvestorBarclays Agg Bond Index InflationSource: Dalbar, Inc. 2011 Quantitative Analysis of Investor BehaviorAnnualized Returns for the 20 Years Ended 12/31/2010
  • 23. Managed Account Target Maturity Target RiskStructure Managed account structurestypically use an array ofunderlying products andallocate to them based oninformation known about theparticipant. There are a finitenumber of portfolios aparticipant may be invested inbased on the data known.Participants are invested in asingle fund with apredetermined glidepath thatbecomes more conservative asa participant nears a specifiedage (typically 65).Target risk defaults are typicallya single balanced fund thatallocates between stocks andbonds in a manner consistentwith its prospectus.Pros Managed account solutionsincorporate far more knowndata about a participant, suchas wages, which has a materialimpact on investment allocationstrategy. Some managedaccount solutions also allowcustomization of the analyticsto incorporate known dataabout the population beingserved, such as turnover.Provides some customizationfor participants with only a date-of-birth variable. Typically is alower cost alternative to otherdefault investment structures.A balanced fund is the simplestof the default investmentstructures, a single investmentproduct for any participant whofails to make an election orwishes to delegate investmentallocation and monitoring.Cons Can be more expensive asinvestment product costs arecompounded by a managedaccount fee.Age is an important factor indriving asset allocation strategy,but not the exclusive factor.Additionally, target date fundsare typically closed solutions.Target risk solutions invariableprovide too much volatility forolder works and too little equityexposure for younger workers.ADDRESSING RETIREMENT READINESS23“Easy” Investment Structures
  • 24. ADDRESSING RETIREMENT READINESS24Investment Returns Cannot Fix Savings ProblemsPercentile Single Target-Date FundManagedAccountAll OtherParticipantsMean 3.93% 3.65% 3.76%5th 3.62% 2.20% -0.02%25th 3.62% 3.08% 2.66%50th 3.90% 3.66% 3.80%75th 3.90% 4.22% 4.64%95th 4.65% 5.06% 8.09%Source: Vanguard 2011 “Participants During the Financial Crisis: Total Returns 2005-2010”5 Year Annualized Returns (Period Ending 12/31/2010)
  • 25. • Tiered Methodologies are Preferable• Simplifies Decision-Making• Employee communication is clearer• Decision-making is easier• Offers Meaningful Choices to Participants• Acknowledges participants are different• No one-size-fits-all choice is available• Participants want different optionsADDRESSING RETIREMENT READINESS25Decide Investment Menu Structure
  • 26. • Ability to Build Globally DiversifiedIndex Portfolio• Low Cost• Broad Diversification• Style Specific Actively ManagedFunds for Active Participants• Optional Self-Directed BrokerageAccount for Most ActiveParticipantsADDRESSING RETIREMENT READINESS26Index Tier OptionAsset Allocation Funds (i.e. TargetMaturity, Target Risk, etc.)Core Index FundsActive Style Funds(Optional) Self-Directed BrokerageAccount / Mutual Fund Window
  • 27. Education has LimitsADDRESSING RETIREMENT READINESS27“…policy makers should be very concerned that retirement education does notincrease the likelihood that financially vulnerable groups – women, personswithout a college degree, and particularly persons with lower incomes – willsave their distributions”U.S. Social Security Administration Office of Policy. “Does Retirement Education Teach People to Save PensionDistributions?”Peer behavior may be as or more impactful on participant savings behaviorthan employee educationE. Duflo, E. Saez / Journal of Public Economics 85 (2002)
  • 28. Employee Education TipsADDRESSING RETIREMENT READINESS28During Enrollment1. Focus education on financial literacy and savings behaviors2. Deemphasize the importance of investment selection on retirement planparticipation3. Do not require education as a predecessor to participation4. Appreciate the importance of peer group behavior and leadership infurthering retirement plan performanceDuring Accumulation1. Begin educating on external factors on retirement(healthcare, insurance, social security, etc.)2. Highlight the effectiveness of current behaviors and the culture of savingsand participation3. Provide access to additional personal education resources to validatesavings goals and structure
  • 29. Pre-Retiree NeedsADDRESSING RETIREMENT READINESS29Viewing the participant as a whole1. Bringing retirement plan projections to a fine point• External assets• Spousal income• Spending needs• Healthcare costs/resources• Understanding federal and state resources2. Advice for participants on how to secure and protect accumulated savings• Asset allocation• Liquidity constraints• Comprehensive retirement planning3. Transitioning accumulations to income• Annuity options• Income planning
  • 30. The Optimal Plan DesignADDRESSING RETIREMENT READINESS30Easy toStartSafe to Leave1. Automatic Enrollmentand investment2. Automatic escalationtowards full retirementpreparedness1. Limit loans2. Limit hardships3. Encourage retirementrollover1. Extensiveeducation, planning, and projections2. Focus on retirementas the goal
  • 31. Five Steps to Improving Your Plan and YourInstitutionADDRESSING RETIREMENT READINESS311. Evaluate the Current RetirementReadiness of Your Institution as aBenchmark2. Determine Obstacles to New HireParticipation3. Develop Mechanisms to Move NewHires Towards Adequate IncomeReplacement4. Plug the Holes• Current loan demographics• Hardship withdrawal impact5. Build the Communication Plan toSupport the Objective• Develop and Education PolicyStatement• Early emphasis on savings• High-touch participant advice andfinancial planning for pre-retireesRemoveobstacles toparticipationImprovedeferral ratesandparticipantbehaviorPlug holesEducatetowards thegoal of asuccessfulretirementMeasure PlanEffectiveness
  • 32. DisclosuresADDRESSING RETIREMENT READINESS32Multnomah Group, Inc. is an Oregon corporation and SEC registered investmentadviser.Investment performance and returns are based on historical information and are nota guarantee of future performance. Investing contains risk. Some asset classesinvolve significantly higher risk because of the nature of the investments and thelow liquidity/high volatility of the securities.Any information and materials contained herein or on our website are provided forgeneral informational purposes only and are not intended to be comprehensive forany particular subject. Multnomah Group utilizes information from third partysources believed to be reliable but not guaranteed, and as a result, information isprovided to you "as is." We do not represent, guarantee, or provide any warranties(either express or implied) regarding the completeness, accuracy, or currency ofinformation or its suitability for any particular purpose. Multnomah Group shall notbe liable to you or any third party resulting from any use or misuse of informationprovided.Receipt of information or materials provided herein or on our website does notcreate an adviser-client relationship between Multnomah Group and you.Multnomah Group does not provide tax or legal advice or opinions. You shouldconsult with your own tax or legal adviser for advice about your specific situation.