Annual Report: Defined Contribution Trends

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This report describes cutting-edge trends in the defined contribution retirement market. Mutual Fund Alliance gave the report the 2006 Star Award for best advisor brochure.

This report describes cutting-edge trends in the defined contribution retirement market. Mutual Fund Alliance gave the report the 2006 Star Award for best advisor brochure.

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  • 1. DC Insights
  • 2. Three major themes move to the forefront The latest DC market research shows how plans continue to evolve by: • Propelling employees beyond their irrational behaviors In response to behavioral finance studies documenting irrational saving and investing tendencies, plans are using new approaches to move employees toward financial security. • Building momentum to improve retirement preparedness Despite the stagnating savings rate, workers’ misplaced confidence about their financial preparation grows. Plans are offering services to enhance retirement readiness, even as the idea of a traditional retirement disappears. • Accelerating into a new future Plans are confronting changing attitudes as the Baby Boom generation begins its long march into what have been traditionally called “the retirement years.” Product and service innovations proliferate as plans work to keep pace. This review will help you learn on-the-go so you can accelerate into the constantly changing future. 1 DC Market Review
  • 3. Propelling employees beyond their irrational beha Behavioral finance studies show that educating Plans using automatic enrollment employees is not enough to motivate them to 35% save and invest rationally. They continue to be 30.6% driven by fear. In response, more DC plans now Percent of plans using automatic enrollment 30 offer a range of automated participant services. 25 Automatic enrollment, salary deferral increase, and investment services continued to grow in 20 18.2% popularity in 2005. 15 Of course, automatic services are not a panacea. 9.8% 10 An average of 10.5% of plans use automatic enrollment, up from 8.4% in 2003. It typically 5 3.4% results in participation rates from 85% to 95%, up 0.9% from the national average of 75%.1 The most 0 1-49 50-199 200-999 1,000-4,999 5,000+ common default deferral percentage is 3% of pay, Number of Employees present in 55.8% of plans. Source: Profit Sharing/401(k) Council of America’s 48th Annual The problem of too much choice Survey, 2005. Asking participants to select among a vast array The larger the plan, the more likely it is to of investment options may result in information have adopted automatic enrollment. Often, overload, which can lead to making poor decisions larger plans lead the way and suggest the or none at all.2 This overload reaction appears in services that will become more important everyday consumer transactions. A behavioral among smaller plans in the future. experiment conducted in a grocery store included two displays of jams: One had six flavors, the other 24. The 24-jam display attracted six out of 10 shop- pers, but only 3% bought a jar there compared to 30% buying a jar at the display with six choices. DC Market Review 2
  • 4. aviors Reconsidering the defaults Employees rate appeal of plan features on decision to enroll In the past, plan sponsors typically used a money market option as their default investment because Target date-based fund 66% it is considered a safe, short-term option. But that Automatic increase 55% same inertia that kept employees from voluntarily enrolling, also keeps them from moving their Matching contribution (up to 3% of employee pay) 51% money into a long-term allocation that may better Lifestyle fund (a fixed allocation) 49% meet their retirement investing goals. Now more Managed account 35% plans are reevaluating the default investment option and choosing target date-based funds as a 0% 10% 20% 30% 40% 50% 60% 70% more appropriate solution. Percent of employees who would be likely to enroll because of each feature Source: EBRI 2005 Retirment Confidence Survey. By automatically investing participants’ assets in target date-based funds, sponsors may protect Eligible employees rated these as the top five features that would make them “much more” or “somewhat themselves from fiduciary concerns related to more” likely to participate in the plan if offered. poor allocation. For example, many plan partici- pants offered company stock tend to overindulge A match that fails to spark in it. Among plans that offer company stock and Research designed to isolate the impact of the no stable value option, nearly 27% of the account match reveals that it may not pack as much punch balances of the plan are in company stock. About as previously thought. While the match certainly a quarter of those who invested in company MOVING YOUR BUSINESS AHEAD appeals to a majority of employees, researchers stock have more than 40% of their account bal- • Do we (or are we considering) offering automated have discovered that about 60% of non-highly ance in it.3 plan services? compensated workers would participate in the plan regardless of the match. The match would • Have we evaluated our investment lineup to induce just 10% more to join the plan.4 assess if it results in information overload? • If automatic enrollment is used, have we recently evaluated the default investment option? • In what ways do we assess the real impact of our plan features and design on participant behavior? 3 DC Market Review
  • 5. Building momentum to improve retirement prepare In the story Alice in Wonderland, nonsense reigns Workers’ beliefs lack a factual basis and the illogical is celebrated. Each year, findings At the root of workers’ misplaced confidence is a from the Employee Benefit Research Institute lack of knowledge. For example, EBRI’s survey (EBRI) Retirement Confidence Survey uncover shows that 66% believe they will reach their sav- workers’ own version of a retirement wonderland. ings goal by the time they stop working, even It is a world in which employees say they are con- though they have not calculated how much they fident they’ll have enough savings at retirement, will need. Perhaps the most overlooked retirement while only half report savings of $25,000 or more expense is health care. Experts estimate health care and the percentage of Americans who have saved alone could add 20% (or more if long-term care is any money for retirement has stalled since 2001. included) to the amount of preretirement income that workers will need to replace in retirement. Participants’ average account balances $200,000 Replacement income projections $181,622 180,000 DC plans are replacing DB plans as the primary 160,000 employer-sponsored retirement benefit. In light 140,000 of this, the plan industry is asking itself whether 120,000 DC plans will yield enough income for retirement. 100,000 80,000 A recent study showed that the replacement 60,000 $56,878 income for the first year in retirement would be 40,000 half of pre-retirement earnings for the lowest- 20,000 $19,926 income worker, and two-thirds for the highest- income worker (assuming steady employment 0 Median All participants in their 60s and a continuous savings rate).5 Source: EBRI 2005 Retirement Confidence Survey. The average account balance of partici- pants in their 60s with a tenure of 30+ years is down 13.5% since 1999. DC Market Review 4
  • 6. edness Retiring later may boost projected retirement income at all income levels Retiring at age 60 Retiring at age 70 Lowest — 38% Lowest — 67% Low Middle — 41% Income Levels Low Middle — 74% High Middle — 45% High Middle — 82% High — 50% High — 94% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Replacement Income Rate Source: Pension Research Council of The Wharton School, 2005. By delaying retirement 10 years, workers at all four income levels born between 1965 and 1974 can radically improve their replacement income rates. MOVING YOUR BUSINESS AHEAD • Do we provide tools to help employees calculate how much they’ll need for retirement? • Do we educate employees about total potential expenses in retirement? • Do we provide tools to project retirement replacement income from DC plan savings? 5 DC Market Review
  • 7. Accelerating into a new future The traditional picture of retirement is obsolete Prepare for a grayer workforce as the Baby Boom generation begins its long With the sheer numbers of Baby Boomers plan- march into retirement. This group sees retire- ning to stay in the labor force past the traditional ment differently, according to a recent national retirement age, the labor force will age. In fact, by survey.6 For example, two-thirds view this period 2014, the percentage of workers between ages 55 as a time for continued productivity and only 13% and 74 in certain fields is expected to skyrocket expect to stop working entirely. to 41%, according to the Government Accountability Office. Compare the Boomers’ orientation of retirement as a “productive period” to responses from More older workers stay on the job today’s retirees who are working for a more 100% immediate reason—54% say they’re back at work 90 because they needed more income, the same Percent of workers age 65-69 staying on the job 80 study reports. 70 68% Boomers expect to work after retiring 60 57% 51% 50 40% 40 30 30% Expect not to 20 Women Women work Men Men 10 70% 0 Expect to work 1996 2005 Source: Congressional Research Service 2005. Since 1996 the percent of men and women between ages 65-69 staying on 7 out of 10 expect to continue to work full-time the job increased 11%. or part-time after retiring from their main job. DC Market Review 6
  • 8. Americans retiring later—just as they did in the past 30% 27% 28% 25 Percent age 65+ still working 20 22% 19% 18% 16% 19% 15 17% 16% 10 Will it go this high or higher? 5 This graph shows the percentage of Americans age 65 or older still working full time. Note that 0 in 1995 the trend began to reverse as more 1965 1970 1975 1980 1985 1990 1995 2000 2004 2010 2015 2020 seniors remained at work after age 65. Source: U.S. Department of Labor, Bureau of Labor Statistics, 2005. More workers phase into retirement retirement income. When offered within the plan, Plan sponsors must acknowledge and respond to participants have the choice to purchase guaran- teed income through their regular salary contri- MOVING YOUR BUSINESS AHEAD the trend of a grayer workforce, many of whom butions. • Are we prepared to accommodate an older work- will want to “phase out” of their jobs gradually— force and the expectations they bring, including in their 60s and beyond. It means sponsors must Finally, from a service perspective, these new more flexible schedules and customized benefits? adjust their communications materials and plan- ning tools to accommodate an older, part-time work patterns will require more hands-on guid- • Do our current plan investments and services employee base sooner rather than later. ance to help participants determine both an fully take into account the demographic trends? appropriate retirement transition strategy and a • Have we considered offering annuities in our It also suggests that more plans may add sustainable withdrawal rate from their accumu- investment lineup? deferred annuities to their 401(k) investment lated assets. • Have we developed communications to guide lineup. Annuities respond to the concern of out- workers planning to phase into retirement? living assets by providing a guaranteed source of 7 DC Market Review
  • 9. Staying ahead in this dynamic arena As you review the information presented in this report and consider its implications for your organization, you will recognize the importance of staying current in this dynamic arena. New research is being conducted continually to enhance our understanding of the DC market. We will continue to share our insights as we accelerate into a new future. For more information, contact your T. Rowe Price internal sales consultant at 1-866-244-1762. DC Market Review 8
  • 10. references 1 “The Automatic 401(k): A Simple Way to Strengthen Retirement Savings,” supported by The Pew Charitable Trusts in partnership with Georgetown University’s Public Policy Institute and the Brookings Institution, 2005. 2 A study by Sheena S. Iyengar and Mark R. Lepper, “When Choice Is Demotivating: Can One Desire Too Much of a Good Thing?” at Columbia University, reported in The Journal of Finance, Vol. 52, No. 4, August 2002. 3 Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI) participant database. 4 A study by Olivia Mitchell, Stephen Utkus, and Tongxuan Yang, “Turning Workers into Savers: Incentives, Liquidity, and Choice in 401(k) Plan Design” at The Pension Research Council of The Wharton School, 2005. 5 A working paper by Sarah Holden and Jack VanDerhei, “The Role of 401(k) Accumulations in Providing Future Retirement Income” at the Pension Research Council of The Wharton School, 2005. 6 Scott Reynolds, Neil Ridley, and Carl Van Horn, Ph.D., “A Work-Filled Retirement: Workers’ Changing Views on Employment and Leisure,” at Rutgers University, August 2005.