Meeting Plan Participants Where They Are
The impact of the COVID-19 pandemic and the ongoing variant spread has transformed the U.S. workforce, causing many to retire earlier than planned, others to retire later than planned, and adding to concerns about financial security across the board. For defined contribution plan sponsors, it has honed their participant retirement outcomes using a wider array of products and services, and more targeted messaging on retirement security.
“A lot of people don’t have a solid understanding of how savings today can translate into future income and, when they reach retirement age, they are surprised that their savings don’t generate more income,” said Jennifer DeLong, senior vice president, managing director and head of defined contribution at AllianceBernstein. “Plan sponsors are more focused on how they can design DC plans better and how they can develop tools that provide participants with greater retirement security.”
“Different groups of people experienced the effects of the pandemic and the [provisions of] the CARES Act in different ways. We have to think about how to meet different needs in the moment, or we’ll fall short when retirement comes,” said Lorie Latham, senior defined contribution strategist for the Americas division at T. Rowe Price. “Increasingly, we realize that the unique needs of individuals have to be taken into consideration along the entire retirement journey. As we reset priorities, there’s a greater need to address financial wellness with a specific focus on retirement preparedness and retirement income.”
As DC plans grow in size, plan sponsors realize the gravity of their role in encouraging financial wellness among participants through improving their financial knowledge and helping maximize long-term savings while managing areas such as emergency savings, debt management and, more recently, helping pay down student loans. “Financial wellness programs are the top noninvestment focus for plan sponsors, according to T. Rowe Price’s 2020 DC Consultant Study,” said Latham. “As financial wellness programs expand, there’s more specificity about the objectives that sponsors want to pursue.” For example, a DC plan could first offer participant education on how to better manage student or household debt and then expand, with increasing personalization, into messaging that builds financial resilience with the ability to retire on time and the introduction of retirement income options, she said.
Different employers interpret financial wellness differently, depending on what’s most important to their employee base. “A major focus of financial wellness today is debt counseling and student debt management,” said Phil Maffei, managing director of strategic guaranteed income solutions at TIAA. (See TIAA chart.) The legislative environment also supports financial wellness through DC plans. “Secure 2.0 could address employer matches for qualified student loan payments before transitioning to contributions to the retirement plan,” Maffei said, referring to the set of proposed bills in Congress that build upon lifetime income provisions and increase access to retirement plans.
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Retaining Assets is a Driver
Increasingly, plan sponsors want to keep their participants in plan. “In our latest DC consulting survey, 74% of plan sponsors prefer to retain retiree assets, up from 46% in 2015. We see this trend continuing as plan sponsors view their role as [one that helps] their employees up to and through retirement,” said Steve Sapra, executive vice president of client solutions and analytics at PIMCO. (See chart on in plan retiree assets.)
Plan sponsors are making plans more accommodating to retirees, such as allowing distribution flexibility, providing education and tools focused on the decumulation phase and adding investment options for retirement income. “Our research found that nearly half of consultants now recommend creating a tier designed around the specific needs of retirees,” said Jamie Bentley, executive vice president of retirement sales at PIMCO.
“In the past, employers thought it was risky for retirees to remain in plan, but they now realize that it gives [the plan] greater buying power and scale,” said Maffei at TIAA. Keeping their assets in plan could have a number of benefits for participants as well. “Participants have a fiduciary who is selecting and monitoring their investment options, as opposed to figuring it out on their own or finding an adviser.”
“The sponsor-participant relationship has become a two-way street. Participants look to plan sponsors to help them make retirement decisions, while sponsors recognize that offering benefits that provide retirement security is critical in attracting and retaining talent,” said Andrew Stumacher, vice president and managing director of custom defined contribution solutions at AllianceBernstein. “That has led to a shift in a retirement savings-focused plan to a retirement outcome-focused plan that includes comprehensive products and solutions for the decumulation phase,” he added.
Read: Guaranteed lifetime income in retirement could be a critical component of financial wellness
Participants are also demanding — and receiving — more personalization in services that address their own particular circumstances and characteristics. This usually means custom default options and personalized managed-account programs. “You can also incorporate more interesting vehicles like real estate, commodities or lifetime income sleeves into customized programs. It’s where plan sponsors can make the most difference, and it’s where the industry is headed,” said Maffei at TIAA.
Retirement Income Takes Center Stage
As we come out of the pandemic, many employers have doubled down on their efforts to improve the physical and financial wellness of their employees and, increasingly, they are exploring a suite of solutions in retirement income.
“People seem to be thinking more about their own quality of life and, as a result, they seem to be getting their financial houses in order. There’s more of a focus on how they will live in retirement, how they will get that stream of income, how best to manage it and how to hedge against the many risks,” said Maffei at TIAA.
AllianceBernstein’s recent research survey of over 1,000 plan participants, titled Inside the Minds of Plan Participants, found that 64% of participants say that their primary savings goal via their plan is to provide income for retirement (See visual on retirement savings objectives). “This highlights the need for plan sponsors to guide participants into and through the decumulation phase more effectively. Many plan sponsors now realize this, and many participants are saying that they want that kind of support from their employers,” said DeLong.
Plan sponsors have focused on this goal by introducing a range of retirement income approaches, from educational programs to setting the default for all participants to automatically enroll in lifetime income-generating strategies. “We’ve noted a few best practices,” said DeLong. “The first is to recognize that adopting retirement income solutions is not a trend, it’s an imperative. The second is not to start with a product discussion, but rather to find a solution that reflects the plan’s overall demographics, objectives and philosophy. Consider your overall workforce management issues, the ability of plan participants to retire on time and whether you hope to keep participants in the plan for their lifetimes,” she said. “The third best practice is for plan sponsors to build consensus among all key stakeholders — from participants, senior management and human resources to record keepers and consultants — early on in the process,” DeLong said.
A Broadening Scope
Over the past year, the interest in lifetime income solutions has increased along with interest in employee financial wellness and encouragement for plans to offer annuities, and which has been supported by the Setting Every Community Up for Retirement Enhancement Act of 2019. “The entire industry is sharpening its acumen on lifetime income, and we see interest across the market from very sophisticated mega plans to the smaller end,” said Maffei at TIAA.
“The SECURE Act will make 401(k) plans look more like 403(b) plans in terms of their adoption of lifetime income vehicles, as 403(b) plans typically include annuities,” Maffei said. He added that he expects that the Secure 2.0 proposals could allow for the addition of collective investment trusts in 403(b) plans. “In 10 or 15 years, a retirement plan that is designed for retirement but focuses only on the savings phase may or may not meet a future fiduciary standard. We’re only at the start of a new wave in helping participants prepare for the income that they need in retirement,” Maffei said.
Finding the Right Framework
“The [retirement income] solutions and services available in the market today are overwhelming for the average plan sponsor, and our industry tends to push product. What we’ve done instead is create a framework that starts with suitability and fit for purpose, to help plan sponsors narrow down the number of options,” said Latham at T. Rowe Price.
Intuitively, as a first step, plan sponsors may provide lifetime income calculators and access to financial advisors; then move into individual offerings in the investment menu lineup, such as stable value or income bond; and then look at multi-asset strategies, like target-date funds with a managed payout or an embedded annuity, said Latham. “But [all that] can be a lot for a plan sponsor to factor in at the same time.”
A Thoughtful Review
A better approach for the plan sponsor would be to identify what they want to solve for their plan population and match it to specific income characteristics, Latham said. They can then assess each available solution more effectively, based on fiduciary alignment, operational and administrative appetite, and specific workforce needs. In addition, “sponsors will do well to be attentive to broader things, like retiree spending patterns, because it may challenge their assumptions around how income needs evolve over time,” she said. It’s important to challenge assumptions such as, for example, the idea that nondiscretionary or needs-based spending patterns are static, which is associated with the assumption that needs-based spending should be connected to guaranteed income or an installment-like solution, Latham said. “The actual spending data shows that spending patterns vary quite a bit. We have to be really careful about making assumptions that a guarantee will be universally applicable to all.”
Some plan sponsors can become paralyzed with the complexity of solving for heterogenous profiles of retirees. These sponsors need more familiarity with lifetime income solutions. “A number of plan sponsors are looking into dedicated retirement tiers on their menus. Right now, there aren’t many products designed for retirees, mainly because historically, plans have not retained those participants,” pointed out Rene Martel, managing director and head of retirement at PIMCO. “We have created solutions around the most important elements, which include maximizing income potential, flexibility to access capital as retirees’ circumstances or objectives evolve, and simple delivery. One example is a dual qualified default investment alternative, [or QDIA,] in which the retirement income component will kick in for people who are close to 60 or 65 years,” Martel said.
A Plan-Dependent Approach
“The right retirement income solution for every plan is dependent on that plan’s philosophy and its unique participants. That said, our approach is an in-plan solution. To get those workplace management benefits, you need as many people as possible using it,” said Stumacher at AllianceBernstein. “An in-plan solution is also more seamless when a participant transitions from working to retiring, which is similar to a [defined benefit] plan,” he noted.
“Most plan sponsors and participants prefer a guaranteed option, which includes an annuity within the default. We take a target-date portfolio — either customized or not — and adapt it to each individual’s desired retirement age. We then add the option of income through a guaranteed lifetime withdrawal benefit. Upon retirement, a participant can decide how much income to guarantee,” he explained. “When you combine these variable factors, the program becomes highly personalized, but it’s done in a way that is much more cost-effective than what they could get outside in the retail marketplace. You also prevent participants from trying to self-manage drawing down their balances in retirement, which everyone agrees most are ill-equipped to do.”
“Retirees need income-oriented investment strategies, but they also show a strong preference for retaining wealth and, in some cases, growing wealth,” said Sapra at PIMCO. “For those who are reluctant to draw down balances, it’s critical that the portfolio generate a high and consistent level of income because that may be their primary source of funds over time,” he noted.
Wider Array of Solutions
Appropriate fixed-income investment solutions for retirees tend to be credit oriented. “Traditional core bonds have relatively low prospective returns given today’s low government-bond yields. Therefore, investments with a diversified credit orientation will be necessary to generate that higher level of income,” Sapra said, adding that blended fixed-income and equity solutions could work, but need to be tailored to manage the equity risk.
“Retirees have also shown a preference for liquidity and a preference for simplicity. Successful retirement income solutions will have both,” Sapra said. Plan sponsors could consider adopting a dual QDIA approach with an embedded retirement income solution, where participants would automatically be transferred into the income solution at a particular threshold of age level or balance amount, he said.
TIAA has long provided access to in-plan lifetime income vehicles, whether fixed or variable annuities, said Maffei. “We see the interest in fixed annuities, guaranteed minimum withdrawal benefits, single-premium immediate annuities and qualified longevity annuity contracts.” Some of these products have an accumulation phase, whether it’s a fixed interest rate or a variable market-based return. “Making these vehicles available in-plan not only has the benefit of their investment attributes, but [these vehicles] also provide the option, and not the obligation, to use a portion of the savings built up in them to purchase a lifetime income stream at retirement.”
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In addition, said Maffei, having these vehicles in-plan during the accumulation phase helps participants get more comfortable annuitizing. “One successful solution is a sleeve of a fixed annuity contract inside a packaged structure, like a custom target-date fund, a model portfolio or a managed account,” Maffei said.
“We are advocates for a suite of retirement income solutions that provides an ability to tackle a range of income characteristics. In our survey of plan sponsors, the top two important characteristics [for plan participants] were adequacy, Will I have enough? and income duration, Will it last? In some ways, they contrast,” said Latham at T. Rowe Price. Seeking income and having enough savings requires growth, and while there would not likely be a guarantee connected to solving for adequacy, providing income duration could mean there’s a guarantee or some type of floor, she said. “This tells us that individuals will likely need more than one solution.” In the plan sponsor survey, the next ranked characteristics were asset growth, income volatility, asset liquidity and the ability to adapt a portfolio based on circumstances. “Overall, this demonstrates that we need to give participants access to solutions that are fit for purpose and their own unique needs,” Latham added. (See chart on retirement income characteristics).
Embracing Customization
Customization is a natural evolution in the DC space. “There are a lot of one-size-fits-all solutions, but one size fits all means one size fits nobody,” said Maffei at TIAA. For instance, participants in some industries, like construction tend to retire earlier, while those in other industries, like accounting or law, often retire later. “The same off-the-shelf target-date fund wouldn’t work the same way for both of those constituencies, but customized vehicles, like unitized plan-specific target-date funds or custom-model portfolios and managed accounts, are structured to take those differences into account,” said Maffei.
“For more than 15 years,” said Stumacher at AllianceBernstein, “We’ve been offering custom glidepaths for all types and sizes of plans… We encourage every plan to at least consider a custom solution, because they can achieve much better outcomes. While they may require additional analysis and more administration, if you can get a better fit for your population, you’ll get better results.”
“We often customize the shape of the glidepath, and some plans decide to include nontraditional asset classes, like real assets, commodities and more defensive equities. Some plans incorporate a blend of active and passive management or a combination of specific asset managers,” Stumacher said. “Plan sponsors who want to offer lifetime income benefits can fold that in by incorporating annuities into a custom glidepath as well.”
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Most off-the-shelf glidepaths are calibrated around an average participant profile in each of the different vintages. “If your plan population characteristics don’t deviate materially from average population data, an off-the-shelf target-date fund will work well and will help to avoid the incremental cost associated with building and maintaining a custom target-date fund,” said Martel at PIMCO. But a custom solution can work more effectively when the plan demographics are meaningfully different from the market averages in terms of income and wealth levels, access to a DB plan, contribution rates and life expectancy, he said.
Other scenarios for custom solutions are when plan sponsors want to offer participants exposure to asset classes, such as hedge funds and private equity, that are not generally accessible through an off-the-shelf TDF, or when sponsors seek manager diversification within the QDIA. “Most off-the-shelf target-date funds are single-manager complexes. Whether it’s a question of having a best-in-breed manager in each asset class or adding diversification from a manager standpoint, a custom solution would make sense,” Martel said.
However, Latham pointed to T. Rowe Price’s experience with some plan sponsors who found the custom solutions too burdensome. “We find that many plan sponsors are comfortable with off-the-shelf solutions, because a custom solution comes with a heavy administrative burden, unless it’s outsourced.” Some plan sponsors that implemented a custom glidepath in the past are now reconsidering that decision, based on the time, effort and expense they have had to invest into administration. Although “some sponsors are very happy with a custom solution, others say, on a net-net basis, that it hasn’t brought the expected value. We’ve seen some very large plans unwind” their custom solution, she said. “We always focus on establishing goals, objectives and a plan mission to establish how we study their workforce, define the plan’s parameters and make recommendations around implementation — a higher- or lower-equity glidepath, active, passive or blend, or something custom.”
Managed accounts as the default
While custom target-date funds can serve a range of plan objectives, they don’t solve the issue of customization at the participant level. “If you have meaningful dispersion among your own participants in terms of wealth levels, access to a DB plan and contribution rates, better QDIA solutions might include personalized target-date funds — a strategy that we have recently launched — or traditional managed accounts,” said Martel at PIMCO.
“There’s no doubt that personalized managed accounts could deliver more precise outcomes than off-the-shelf target-date funds. However, custom-model portfolios or plan-level managed accounts fit right in the middle. They’re less expensive than fully personalized versions, but they provide a higher level of customization,” said Maffei at TIAA. Whether the plan adopts a custom-model portfolio program or a personalized managed account, both enable the addition of sleeves of lifetime income vehicles and other asset classes, like real estate, more easily, he added.
Older participants who are moving into retirement tend to be heavier users of managed accounts. “One innovation that plan sponsors are considering is to use target-date funds during the accumulation phase and pivot to a hybrid or dynamic strategy that uses managed accounts as a participant reaches retirement,” said Latham at T. Rowe Price. “Once we get to that phase where a participant has a unique set of needs, a managed account can bring greater personalization and could make sense.”
Looking ahead, technology will enable more personalized solutions at lower costs. “There are many additional data points beyond age that can be used to refine a target date by participant, like salary levels, account balances, deferral rates and company-match rates. Most record keepers capture them, and there’s no reason they can’t be used to enhance a participant’s target-date glidepath,” said Bentley at PIMCO. “Our research shows that 84% of target-date managers believe that customization at the participant level is either highly or somewhat likely in the next generation of target-date products. We’re driving towards a more precise target-date fund that’s simple, easy to implement, and provides affordable personalization to the participant regardless of engagement.”
Embracing ESG
Another big focus for many plan sponsors today is considerations on how to integrate environmental, social and governance factors into their plan investment menu, but these efforts are still at a very early stage for most plans. “The whole industry is waiting for more clarity from Washington. “Very few sponsors want to make a move, and until the financial factor rules are officially remapped or repealed, we’re in a wait-and-see mode,” said Latham at T. Rowe Price, referring to the Department of Labor latest guidance for fiduciaries when making investment decisions, which did not include explicit reference to ESG factors.
Still, the industry expects that ESG will only grow in importance across the board. The AllianceBernstein Inside the Minds of Plan Participants research showed that 83% of participants believe that it’s either important or very important that the investment options in their company’s DC plan align with their core ethical values. “Additionally, two-thirds say that they’d be very likely to invest in ESG funds if they were available and performance and fees were comparable to other investments in the plan,” said DeLong, noting that DC plans are evaluating ESG funds and asking more ESG-related questions in requests for proposals. “In our research, about two-thirds of plan sponsors say that applying ESG factors to the overall fundamental investment analysis is a fiduciary duty.”
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