TOP OF MIND
Trends in DC Webinar
The defined contribution business continues to evolve. After years of exhorting employees to save for their retirement years, now DC plan sponsors are more actively developing ways for participants to convert their savings into retirement income.
Paying more attention to the decumulation phase includes addressing economic and market issues. For instance, higher interest rates are leading to changes in how best to manage or offer fixed-income investments across the board, including target-date glidepaths, strategic core menu options and managed accounts. Additionally, financial wellness and communication programs are pivoting to educate participants on how best to weather changes in market cycles and develop financial resilience across market environments.
Focus on income
Retirement income is a top focus for DC sponsors, according to Jessica Sclafani, global retirement strategist at T. Rowe Price. “Plan sponsors are moving from purely information gathering to more of an implementation-oriented posture,” she said. “Many are exploring the landscape of available products to identify potential best-fit solutions.”
More clients are making T. Rowe Price’s managed-payout capability available to retired participants, Sclafani added. “At the end of 2023, we had more than 50 DC plans offering our managed-payout capability. We anticipate continued interest among sponsors in supporting retired participants to convert their account balances into a predictable, or paycheck-like, income stream.”
Fixed income is another key topic on DC sponsors’ minds, especially in light of increased volatility in fixed-income markets over recent years, said Sclafani. “We’re partnering with sponsors to rethink the definition of core bonds — we don’t think they necessarily need to be synonymous with just the U.S. Aggregate Bond index.”
In fact, she said, “we see benefits in diversifying participants’ fixed-income exposure to be less reliant on U.S. interest rates. A core bond allocation can still be anchored in exposure to the aggregate [index] but can be complemented by satellite strategies in a multi-manager or white-label construct.”
Sclafani said plan sponsors are looking closely at how their target-date glidepath allocates to underlying fixed-income strategies. “We certainly wouldn’t want to ask participants to make allocation decisions across fixed-income strategies like high yield, emerging market debt or Treasury Inflation-Protected Securities,” she said. “But the beauty of a target-date solution is that we can leave that to the experts who make those calls for participants.”
Furthermore, she said, the fixed-income focus is supported by plan sponsors’ increased interest in providing investments for participants who are nearing or in retirement and growing their fixed-income allocation, whether they are invested in a target-date solution or using investments offered on the plan menu.
Hannah Schriner, managing principal and investment consultant at Meketa Investment Group, said there’s a trend toward active fixed-income management. She encourages DC plan sponsors to review their fixed-income offerings.
Instead of having just a core bond index and a core-plus active solution, “they can explore offering a high-yield fund or revisiting their core-plus fund to make sure that those plus sectors provide adequate opportunity for additional yield pickup,” she said. “We’ve mostly seen this shift toward active instead of passive fixed income in trustee-directed pools, but it’s translating over into participant-directed DC as well.”
Read: A fiduciary’s guide to offering lifetime income
Communication helps durability
Communication with participants should be a priority for DC sponsors, said Brendan McCarthy, Nuveen’s head of retirement investing. He framed this in the context of higher interest rates and the increasing appeal of fixed income — which figure prominently in the development of decumulation strategies.
Retirement plans are intended for the long haul, he said, and designed to weather shifting market cycles. “But participants are prone to short-term thinking, particularly when markets are volatile. It’s important for employers to communicate with employees about their 401(k) plan in this situation because the absence of communication, together with employees seeing things on the news or hearing things about the market from neighbors, can prompt counterproductive thinking,” he said.
Many participants aren’t fully educated on why it’s critical to stay the course during volatile periods, McCarthy added. “This means that a communication vacuum could influence them to take actions that you don’t want in your 401(k) — things like moving to cash or changing allocations in a way that might not align with their long-term retirement goals.”
Spotlight on wellness
An ongoing trend in the corporate world is to position retirement investing as part of a wider emphasis on employee wellness. As T. Rowe Price’s Sclafani put it, “We see employers thinking about their retirement plan more holistically, as part of a broader suite of employee benefits designed to address the needs of an increasingly diverse workforce.”
Sclafani cited T. Rowe Price’s 2023 Defined Contribution Consultant Research Study when specifically referring to financial wellness. “The study’s results demonstrate that as employees continue to express interest in financial wellness programs, consultants and advisors have taken notice,” she said. “In another study we did, participants said they were most interested in learning more about traditional financial wellness topics, such as financial basics, planning and investing. Our research has shown that access to workplace financial wellness programs and services that help participants manage these priorities can be impactful.” (See chart above)
Nuveen’s McCarthy sees wellness as a bigger-picture concept that comprises financial, physical and mental health. “Companies are starting to tie these different wellness programs together. They might have been doing elements of health and fitness separately from financial wellness, but now they’re starting to try to bundle all of them into an integrated offering,” he said.
McCarthy highlights longevity literacy — for example, understanding how long people are likely to live in retirement — as an especially important topic within financial wellness programs. Two sobering statistics put this into perspective: 65-year-olds have a 25% chance of living to age 95 or older, according to U.S. government data, and 40% of Americans are at risk of running out of income in retirement, according to the Employee Benefit Research Institute. In other words, people may live well past their expected lifespans and not have enough income to live on.
Research from the TIAA Institute has found a direct link between longevity literacy and financial outcomes during retirement, McCarthy said. The Institute’s report, titled “An Unrecognized Barrier to Retirement Income Security: Poor Longevity Literacy,” surveyed workers and retirees, and compared strong and weak, or nonexistent, longevity literacy across a number of metrics.
Significant majorities of retirees that have strong longevity literacy reported both that their lifestyle met or exceeded pre-retirement expectations, and that they were confident they’d have enough money to live comfortably throughout retirement. The corresponding percentages for retirees with weak or no longevity literacy were much lower. (See chart below.)
IN SEARCH OF RETIREMENT INCOME
Retirement income is more than simply a hot topic for DC plan sponsors. Participants are demanding it — and they want the income to be consistent, like pension payments. Yet pensions hardly exist anymore. According to the U.S. Department of Labor, 70% of Americans had access to a pension or defined benefit plan in 1975; that number stands at 12% today.
But Nuveen’s McCarthy thinks this trend might be reversing. “Today’s retirees are often referred to as the 401(k) generation. They’re the first generation in the modern era that is predominantly without any form of guaranteed income, and they’re starting to pay attention to that,” he said. “It’s as if the American worker has woken up to the fact that something that the prior generation had has been taken away from them. There’s a lot of talk and demand from employees for the return of a pension system, particularly in labor negotiations.”
While plan sponsors are exploring ways to turn retirement income into more of a pension-like, consistent-paycheck experience, they’re also hesitant to return to the pension structure. McCarthy points out that companies must carry pension obligations on their financial statements and are on the hook for payments to retirees regardless of funded status. Many companies are reluctant to take on such liabilities and assume investment risk.
Must-haves
What are the features that a sound income solution must have? Meketa’s Schriner emphasizes that plan sponsors should focus on flexibility.
“Many participants don’t feel comfortable about deciding today how they want to manage their retirement assets over the long term,” she said. “As you get closer to retirement, you have a better idea of what your overall financial position looks like and how you’d like to receive your plan distributions. You need to be able to choose the income solution that’s right for you at that time and pivot if it changes at some point.”
To Nuveen’s McCarthy, the top must-haves are simplicity, portability and low cost — income solutions should have all three to best meet retirees’ needs.
“Ensuring that the product is simple is crucial to the successful selection and implementation of any plan investment,” McCarthy declared. “Income solutions can be complex and confusing. If the plan’s investment committee finds the product difficult to understand, then the employees are going to find understanding it even more difficult.”
He cites annuities as an example of the need for portability. “The retail annuities of yesteryear, which people sometimes tried to fit inside a 401(k), were very complex and restrictive. Today’s institutional annuities have been designed specifically to go into DC plans and tend to be more portable.”
As for cost, “it just doesn’t seem to go away as one of plan sponsors’ biggest concerns. Sponsors spend years working to get their weighted average expense ratios down, and then an annuity solution can come along whose costs can throw everything out of whack. Fortunately, there are guaranteed and in-plan income products that are low cost.”
Potential solutions
The question of how DC plans can best provide retirement income has a variety of answers.
Nuveen’s McCarthy recommends fixed annuities both as a retirement income solution and as a replacement for part of a bond portfolio. A fixed annuity “can provide a guaranteed growth rate during accumulation without the risk of loss, and it offers the option of lifetime income. You can get bond-like returns without the volatility during accumulation, and then you can convert it into guaranteed income at retirement,” he said.
The road to retirement income appears fairly smooth — yet there are significant bumps that could get in the way of implementation. One of the greatest challenges is turnover in the membership of a company’s investment committee, which can foster the avoidance of fiduciary liability, according to Meketa’s Schriner.
She explained that once new members join the committee, they’re responsible for the plan as it currently exists, which includes all past committee decisions. “If you know that a past committee had implemented an in-plan guaranteed income solution, for instance, then all future committees will be responsible for its oversight. Even if they don’t agree with it, they’re going to be stuck with it,” she said. “They want to take a longer-term approach to retirement, but they’re deterred from doing that because of people changes in the committee in the relatively short term.”
To overcome this problem, Schriner likes the hybrid QDIA, which typically has participants follow their target-date glidepath until a specific number of years before retirement. At that time, their plan assets are moved to a managed account solution that is tailored to their particular circumstances. Schriner emphasized that plans always should offer more than one income option. (See chart below.)
Read: Next, a defined contribution publication. The lifetime income issue
GREATER FLEXIBILITY ON THE MENU
Much rides on the effectiveness of DC plan investment menus. If they’re soundly constructed in terms of diversification and due diligence, plan participants could experience positive outcomes in both the accumulation and decumulation phases. If not, outcomes are more likely to be less favorable and sponsors could be exposed to litigation risk.
Meketa’s Schriner believes that flexibility is the key to menu effectiveness. “Menus and plan design shouldn’t be static,” she said. “They must be able to adapt to a retirement landscape that continues to evolve through new products or solutions, or via legislative or regulatory developments.”
An important part of flexibility, in turn, is the willingness to give participants more menu choices. Schriner points to advice and managed accounts as examples. “We’ve seen an increase in the number of solutions in both of these areas,” she said. “With advice, there used to be two key providers out there and, ideally, they’d both have relationships with record keepers. Now you have several advisers that partner with record keepers to create a more proprietary solution, as well as record keepers providing their own proprietary solutions.”
With the core menu, she added, “we are seeing managed account programs being more flexible about incorporating off-menu investments. That is a great move, because the core menu shouldn’t be designed to meet the needs of the managed accounts’ model portfolios.”
Schriner notes that even target-date funds — the go-to default option for many plans — are getting behind-the-scenes attention that underscores plan menus’ flexibility. “Managers of target-dates are continuously looking to enhance their glidepaths and implementation,” she said. “Plans and committees are becoming more educated, and they’re focusing more on their fiduciary responsibilities when it comes to understanding target-date funds as a default, as well as the glidepath and the broader menu.”
The case for alts
Momentum has been building for some time to include alternative investments, such as private equity, real estate and infrastructure, in DC menus. While there are good reasons to question their appropriateness for retirement plans, with illiquidity being the most prominent, a case in favor of inclusion can be made as well.
Nuveen’s McCarthy does so succinctly: “We believe that there are several advantages to owning alternatives within a retirement portfolio,” he said. “One is diversified returns that can be insulated during times of economic slowdown. Generally, robust yields and even alts’ relative illiquidity can be an advantage, as illiquidity enables accounts to appear less volatile, meaning that participants aren’t as likely to make a knee-jerk decision to sell when the market environment is negative.”
McCarthy also notes that legal questions regarding alternatives, which typically focus on issues of fiduciary liability, while quite real, can be satisfactorily addressed. Legal issues can be overcome as long as investment committees evaluate alternative investment options as they would any plan investment — in other words, analyze them according to the framework of a plan’s governing documentation and consider different choices and managers, he said.
Toward personalization
We’re in an age when things can be personalized perhaps more than ever. Curated internet news delivery and even athletic shoes (“Just do it!”) readily come to mind. So why not DC plan investments?
Indeed, personalization is a growing theme in the DC market, said T. Rowe Price’s Sclafani. “There’s general agreement that the more we know about individual participants, the better we can build portfolios that meet their unique risk and return objectives. That said, personalized investment solutions, like managed accounts, typically come with a higher price tag than other multi-asset solutions. This price differential, along with a concern that participants won’t engage with the personalized solution, has historically served to prevent widespread adoption,” she said.
Sclafani explained how her firm is approaching the personalization conundrum. Later this year, it will be able to support plan sponsors on their record-keeping platform who not only have high conviction in their T. Rowe Price target-date default option, but also want to offer participants a more tailored investment experience.
About 15 years prior to participants’ expected retirement age, “plan sponsors will have the option to transition employees from our target-date solution into a more personalized managed account that would follow a similar investment process and have the same underlying investment building blocks,” she said. “It’s a dynamic structure that enables personalization at the right cost and is consistent with the target-date methodology.”
REGULATIONS ARE FRONT AND CENTER
Without question, the SECURE 2.0 Act of 2022 is the most important piece of legislation that will affect retirement plans in 2024.
One of the act’s provisions that is most consequential for DC sponsors and participants: Employers will be allowed to make employee contributions that match the amount of an employee’s student loan payments, said Meketa’s Schriner. “This provision has great potential, especially for increasing plan participation,” she said. “Affected employees who couldn’t otherwise participate, perhaps due to their financial circumstances, now can participate without having to contribute. It’s going to be a game-changer for plan sponsors and for a lot of individuals,” she said.
Several other provisions should be significant for sponsors as well, according to T. Rowe Price’s Sclafani. One relates to plan eligibility for long-term part-time workers: Starting this year, it requires three years of service, per the first SECURE Act; and starting in 2025, the requirement declines to just two years, per SECURE 2.0.
Due to SECURE 2.0, plans will be able to offer emergency savings accounts, she said, which previously lacked clarity under ERISA and the U.S. tax code. But she cautioned that this might remain problematic. “While we agree with the intention of the plan-linked emergency savings account, the way that it’s structured in SECURE 2.0 presents operational complexities that we believe may prevent widespread adoption,” she said.
More to think about
Schriner and Sclafani pointed to additional legal and regulatory matters that DC sponsors should have on their radar. For Schriner, these include the inability of 403(b) plans to offer collective investment trusts; ongoing uncertainty surrounding the DOL’s proposed fiduciary rule about investment managers providing advice; and the as-yet unresolved status of the DOL rule allowing retirement plans to consider environmental, social and governance issues when making investment decisions.
Additional matters that should keep sponsors busy start with the tax treatment of catch-up contributions, said Sclafani. SECURE 2.0 mandated that catch-ups by employees earning up to $145,000 be made on a Roth, or after-tax, basis starting in 2024. However, the Internal Revenue Service granted a two-year delay in August 2023, meaning that all catch-ups are made with pretax dollars through 2025.
“We also anticipate further conversation around federal auto-IRA, or auto-401(k), programs and Social Security reform,” she added. “While we don’t expect to see Social Security reform in an election year, we believe it’s an issue that Washington will eventually have to tackle, given that it’s a core component of retirement income security for many Americans.”
The appeal of AI
On the compliance front, another area for plan sponsors to watch is the use of artificial intelligence. While few days go by without AI making negative news, Meketa’s Schriner said DC plans are using AI in ways that are quite positive.
“One of the biggest ways that AI helps plans is by increasing financial literacy, which then increases the understanding of the entire program,” she said. “Plan sponsors are able to customize communications and engagements at the participant level, the HR level and the investment committee level. AI enables the industry to create participant profiles that better represent individuals in a plan and meet them where they are in their career, which might resonate with them more.”
Schriner adds that record keepers have a wealth of data on their platforms, which they can aggregate to create solutions that better align with participants’ needs and behaviors. “With AI, that analysis can be done so quickly that individuals can feel as though they are understood and their needs are being addressed in real time. Record keepers are continually reinvesting in technology such as AI to improve their capabilities,” she said.
Trends in DC Webinar
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