Annual Report: Defined Contribution Trends
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Transcript of Annual Report: Defined Contribution Trends
DC Insights
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.
Three major themes move to the forefront
1 DC Market Review
DC Market Review 2
Behavioral finance studies show that educatingemployees is not enough to motivate them tosave and invest rationally. They continue to bedriven by fear. In response, more DC plans nowoffer a range of automated participant services.Automatic enrollment, salary deferral increase,and investment services continued to grow inpopularity in 2005.
Of course, automatic services are not a panacea.An average of 10.5% of plans use automaticenrollment, up from 8.4% in 2003. It typicallyresults in participation rates from 85% to 95%, upfrom the national average of 75%.1 The mostcommon default deferral percentage is 3% of pay,present in 55.8% of plans.
The problem of too much choiceAsking participants to select among a vast arrayof investment options may result in informationoverload, which can lead to making poor decisionsor none at all.2 This overload reaction appears ineveryday consumer transactions. A behavioralexperiment conducted in a grocery store includedtwo displays of jams: One had six flavors, the other24. The 24-jam display attracted six out of 10 shop-pers, but only 3% bought a jar there compared to30% buying a jar at the display with six choices.
Plans using automatic enrollment
Source: Profit Sharing/401( k) Council of America’s 48th Annual Survey, 2005.
The larger the plan, the more likely it is tohave adopted automatic enrollment. Often,larger plans lead the way and suggest theservices that will become more importantamong smaller plans in the future.
Propelling employees beyond their irrational beha
35%
30
25
20
15
10
5
1-49 50-199 200-999
Number of Employees
Perc
ent o
f pla
ns u
sing
aut
omat
ic e
nrol
lmen
t
1,000-4,999 5,000+
0.9%
3.4%
9.8%
18.2%
30.6%
0
3 DC Market Review
Reconsidering the defaultsIn the past, plan sponsors typically used a moneymarket option as their default investment becauseit is considered a safe, short-term option. But thatsame inertia that kept employees from voluntarilyenrolling, also keeps them from moving theirmoney into a long-term allocation that may bettermeet their retirement investing goals. Now moreplans are reevaluating the default investmentoption and choosing target date-based funds as amore appropriate solution.
By automatically investing participants’ assets intarget date-based funds, sponsors may protectthemselves from fiduciary concerns related topoor allocation. For example, many plan partici-pants offered company stock tend to overindulgein it. Among plans that offer company stock andno stable value option, nearly 27% of the accountbalances of the plan are in company stock. Abouta quarter of those who invested in companystock have more than 40% of their account bal-ance in it.3
A match that fails to sparkResearch designed to isolate the impact of thematch reveals that it may not pack as much punchas previously thought. While the match certainlyappeals to a majority of employees, researchershave discovered that about 60% of non-highlycompensated workers would participate in theplan regardless of the match. The match wouldinduce just 10% more to join the plan.4
Eligible employees rated these as the top five features that would make them “much more” or “somewhatmore” likely to participate in the plan if offered.
aviors
MOVING YOUR BUSINESS AHEAD• Do we (or are we considering) offering automated
plan services?
• Have we evaluated our investment lineup toassess if it results in information overload?
• If automatic enrollment is used, have we recentlyevaluated the default investment option?
• In what ways do we assess the real impact of ourplan features and design on participant behavior?
0% 10% 20% 30%
Percent of employees who would be likely to enroll because of each feature
40% 50% 60% 70%
66%
55%
51%
49%
35% Managed account
Lifestyle fund (a fixed allocation)
Matching contribution (up to 3% of employee pay)
Automatic increase
Target date-based fund
Source: EBRI 2005 Retirment Confidence Survey.
Employees rate appeal of plan features on decision to enroll
Workers’ beliefs lack a factual basis At the root of workers’ misplaced confidence is alack of knowledge. For example, EBRI’s surveyshows that 66% believe they will reach their sav-ings goal by the time they stop working, eventhough they have not calculated how much theywill need. Perhaps the most overlooked retirementexpense is health care. Experts estimate health carealone could add 20% (or more if long-term care isincluded) to the amount of preretirement incomethat workers will need to replace in retirement.
Replacement income projections DC plans are replacing DB plans as the primaryemployer-sponsored retirement benefit. In lightof this, the plan industry is asking itself whetherDC plans will yield enough income for retirement.
A recent study showed that the replacementincome for the first year in retirement would behalf of pre-retirement earnings for the lowest-income worker, and two-thirds for the highest-income worker (assuming steady employmentand a continuous savings rate).5
In the story Alice in Wonderland, nonsense reignsand the illogical is celebrated. Each year, findingsfrom the Employee Benefit Research Institute(EBRI) Retirement Confidence Survey uncoverworkers’ own version of a retirement wonderland.It is a world in which employees say they are con-fident they’ll have enough savings at retirement,while only half report savings of $25,000 or moreand the percentage of Americans who have savedany money for retirement has stalled since 2001.
Participants’ average account balances
Source: EBRI 2005 Retirement Confidence Survey.
Building momentum to improve retirement prepare
$200,000
180,000
160,000
140,000
100,000
60,000
20,000
Median All participants in their 60s
$19,926
$56,878
$181,622
0
120,000
80,000
40,000
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
Retiring later may boost projected retirement income at all income levels
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 canradically improve their replacement income rates.
edness
0% 20%
Retiring at age 60 Retiring at age 70
40% 60%
Inco
me
Leve
ls
Replacement Income Rate
70% 80% 90% 100%10% 30% 50%
Lowest — 38%
Low Middle — 41%
High Middle — 45%
High — 50%
Lowest — 67%
Low Middle — 74%
High Middle — 82%
High — 94%
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 potentialexpenses in retirement?
• Do we provide tools to project retirementreplacement income from DC plan savings?
5 DC Market Review
DC Market Review 6
Prepare for a grayer workforce With the sheer numbers of Baby Boomers plan-ning to stay in the labor force past the traditionalretirement age, the labor force will age. In fact, by2014, the percentage of workers between ages 55and 74 in certain fields is expected to skyrocketto 41%, according to the GovernmentAccountability Office.
More older workers stay on the job
Source: Congressional Research Service 2005.
The traditional picture of retirement is obsoleteas the Baby Boom generation begins its longmarch into retirement. This group sees retire-ment differently, according to a recent nationalsurvey.6 For example, two-thirds view this periodas a time for continued productivity and only 13%expect to stop working entirely.
Compare the Boomers’ orientation of retirementas a “productive period” to responses fromtoday’s retirees who are working for a moreimmediate reason—54% say they’re back at workbecause they needed more income, the samestudy reports.
Boomers expect to work after retiring
Accelerating into a new future
100%
90
80
70
50
30
10
1996
57%
40%
68%
51%
2005 0
60
Perc
ent o
f wor
kers
age
65-
69 st
ayin
g on
the
job
40
20
Wom
en
Men
Wom
en
Men
30%Expect not to
work
70%Expect to work
7 out of 10 expect to continue to work full-timeor part-time after retiring from their main job.
Since 1996 the percent of men andwomen between ages 65-69 staying onthe job increased 11%.
7 DC Market Review
retirement income. When offered within the plan,participants have the choice to purchase guaran-teed income through their regular salary contri-butions.
Finally, from a service perspective, these newwork patterns will require more hands-on guid-ance to help participants determine both anappropriate retirement transition strategy and asustainable withdrawal rate from their accumu-lated assets.
More workers phase into retirementPlan sponsors must acknowledge and respond tothe trend of a grayer workforce, many of whomwill want to “phase out” of their jobs gradually—in their 60s and beyond. It means sponsors mustadjust their communications materials and plan-ning tools to accommodate an older, part-timeemployee base sooner rather than later.
It also suggests that more plans may adddeferred annuities to their 401(k) investmentlineup. Annuities respond to the concern of out-living assets by providing a guaranteed source of
MOVING YOUR BUSINESS AHEAD• Are we prepared to accommodate an older work-
force and the expectations they bring, includingmore flexible schedules and customized benefits?
• Do our current plan investments and servicesfully take into account the demographic trends?
• Have we considered offering annuities in ourinvestment lineup?
• Have we developed communications to guideworkers planning to phase into retirement?
This graph shows the percentage of Americansage 65 or older still working full time. Note thatin 1995 the trend began to reverse as moreseniors remained at work after age 65.
Americans retiring later—just as they did in the past
Source: U.S. Department of Labor, Bureau of Labor Statistics, 2005.
30%
Perc
ent a
ge 6
5+ st
ill w
orki
ng
28%
27%
22%
16%
25
20
15
5
1965 1970 1975 1980 1985 1990 1995 2000 2004 2020
0
2015 2010
10
19%
16%17%
18%19%
Will it go this high or higher?
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
references1 “The Automatic 401(k): A Simple Way to Strengthen Retirement Savings,”supported by The Pew Charitable Trusts in partnership with GeorgetownUniversity’s Public Policy Institute and the Brookings Institution, 2005. 2 A study by Sheena S. Iyengar and Mark R. Lepper, “When Choice IsDemotivating: Can One Desire Too Much of a Good Thing?” at ColumbiaUniversity, reported in The Journal of Finance, Vol. 52, No. 4, August 2002.3 Employee Benefit Research Institute (EBRI) and Investment CompanyInstitute (ICI) participant database.4 A study by Olivia Mitchell, Stephen Utkus, and Tongxuan Yang, “TurningWorkers into Savers: Incentives, Liquidity, and Choice in 401(k) PlanDesign” at The Pension Research Council of The Wharton School, 2005.5 A working paper by Sarah Holden and Jack VanDerhei, “The Role of401(k) Accumulations in Providing Future Retirement Income” at thePension Research Council of The Wharton School, 2005.6 Scott Reynolds, Neil Ridley, and Carl Van Horn, Ph.D., “A Work-FilledRetirement: Workers’ Changing Views on Employment and Leisure,” atRutgers University, August 2005.