Can You Get the Best of DB With the Best of DC?...Can You Get the Best of DB With the Best of DC?...
Transcript of Can You Get the Best of DB With the Best of DC?...Can You Get the Best of DB With the Best of DC?...
Speakers:
Toni Brown, CFA, Senior Vice President, Capital Group
John Doyle, Senior Vice President, Capital Group
Can You Get the Best of
DB With the Best of DC? Ideas for “DB-izing” a Defined
Contribution Plan
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or
any other entity, so they may lose value.
Can We Get the Best of DC and the Best of DB?
Employees should be …
• Enrolled
• Saving enough
• Investing appropriately
• Not touching their money until retirement
DB satisfies the above ...
… how to get DC there?
Problem: Unlike DB, the DC System Is Subject to Participant Behavior
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… But We All Know That’s Not the Case for Many
A Tale of Three (Conflicting) Numbers
55%Percentage of workers
who are at least
somewhat confident that
they have enough money
to live comfortably in
retirement1
44%Percentage of workers
who have tried to
calculate how much
money they need to
save for a comfortable
retirement1
$111,000Median 401(k)/IRA
accumulation of older
working households
(heads of household
ages 55 to 64) in 20132
1EBRI, “The 2014 Retirement Confidence Survey,” March 2014.
2Center for Retirement Research at Boston College, “401(k)/IRA Holdings in 2013: An Update From the SCF,” September 2014
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It’s Not Just the Participants’ Problem
Delayed retirement can result in:
• Higher health care costs
• Less efficiency
• Reduced productivity
• Stalled career paths for younger workers
There Are Consequences for Plan Sponsors
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The Planned Retirement Age Has Been Rising
Percentage of Respondents Who Plan to Retire After Age 65
11%
18%21%
31%
36%33%
1991 1999 2004 2009 2013 2014
Survey Year
Source: EBRI, “The 2014 Retirement Confidence Survey,” March 2014.
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It’s Not Just the Participants’ Problem
There Are Serious Consequences for Plan Sponsors
Employees Who Delay Retirement Tend to Rate Their Plans Poorly
Retire Early No Change Retire Later
All Employees
“Plan meets needs” 34% 45% 19%
“Plan does not meet needs” 10% 27% 60%
Age 50+ Employees
“Plan meets needs” 35% 49% 16%
“Plan does not meet needs” 8% 33% 58%
Source: Towers Watson, “Which Employees Are Delaying Retirement and Why?,” September 25, 2014. Note: Based on full-time
employees enrolled in a retirement plan. 2013/14 Global Benefit Attitudes Survey – U.S.
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It’s Not Just the Participants’ Problem
“Disengaged workers are 11 percentage points more
likely to delay retirement and 12 percentage points
more likely to expect to retire at older ages. This
reinforces the supposition that many retirement delays
reflect the employee’s need to keep working rather than
his or her strong connection to work or the employer.
Many of these workers simply can’t afford to retire.”
— Towers Watson
There Are Serious Consequences for Plan Sponsors
Source: Towers Watson, “Which Employees Are Delaying Retirement and Why?,” September 25, 2014.
http://www.towerswatson.com/en-US/Insights/Newsletters/Americas/insider/2014/which-employees-are-delaying-retirement-and-why
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Poll: Can the Existing DC System Lead to
Successful Retirement for Participants?
1. Yes, if implemented to the fullest degree.
2. Maybe, with some tweaks.
3. No, cannot get there from here.
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Can You Get the Best of DB With the Best of DC?
1. The Pros and Cons of DB and DC Plans
2. What’s Stopping DB-ization?
3. Ideas for DB-izing a DC Plan
Agenda
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Pros and Cons of DB Plans
Pros
• Investments are pooled and
professionally managed
• Longevity risk is pooled
• Investment risk is pooled
• Full and automatic enrollment
• No participant investment
knowledge needed
• Company bears risk
• Eliminates participant behavior
variables
Company Bears Risk, but Assets Are Not Portable or Liquid
Cons
• Vesting causes real issues (job
changes)
• Not liquid – pro or con?
• Difficult to understand
• Challenging to see value
• Benefit often lacks visibility to
employee
• Unpredictable for company
• Portability – participant can’t
consolidate
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Pros and Cons of DC Plans
Pros
• Portable
• Liquid
• Benefit is visible to employee
• Company contribution is valued
• Participants have more control
Investments Are Portable (and Liquid) … But Risk Shifts to Participants
Cons
• Participation is voluntary
• Participants often make poor
decisions
• Participant bears risk
• Insufficient savings
• Risks are not pooled
• Employees think they can’t afford
to save
• Employees don’t understand the
money needed in retirement
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Why DB-ize a DC Plan?
Change Plan Structure to Position More Participants to “Get It Right”
What Have Been the Barriers to DB-ization?
Cost Time Complexity Risk Income DB-ization
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The Movement to DB-ize DC Plans
Auto-Enrollment and Auto-Escalation Aim to Give a More DB Experience
Changes Since the 2006 Pension Protection Act
DB-Like
Quality Sought
Full participation
Adequate savings rate
Professionally packaged
and managed retirement
portfolio
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DC Weaknesses
Addressed
Lack of participation
Low savings rate
Inappropriate asset
allocation
DC Change
Auto-enrollment
Auto-escalation
QDIA (e.g., target date)
No auto-enrollment or
auto-escalation, but
considering
Yes, auto-enrollment
with auto-escalation
Yes, auto-enrollment
without auto-escalation
No auto-enrollment or
auto-escalation and not
currently considering
Some Plans Have Yet to Adopt Auto-Enrollment
Auto-Enrollment and Auto-Escalation Are Becoming More Common
Plans Using or Considering Auto-Enrollment or Escalation
26% 18%
26%30%
Source: “Trends in 401(k) Plans and Retirement Rewards: A Report by WorldatWork and the American Benefits Institute,” March 2013
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Poll: What Does Your Plan Offer?
1. Auto-Enrollment
2. Auto-Escalation
3. Considering one or the other
4. Not considering either auto feature
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The Problem: 3% Is Not the Solution
Employers Are Setting the Default Contribution Rate Too Low
0% 9% 10%
53%
11% 11% 5%
Less than 1.0% 1.0%–1.99% 2.0%–2.99% 3.0%–3.99% 4.0%–4.99% 5.0%–5.99% 6.0% or greater
0%
97%
3% 0%
Less than 1% 1.0%–1.99% 2.0%–2.99% 3.0% or greater
Initial Default Employee Contribution for Plans Offering Automatic Escalation
Annual Escalation Rate
Source: “Trends in 401(k) Plans and Retirement Rewards: A Report by WorldatWork and the American Benefits Institute,” March 2013
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Consider Ernie
New Employee — Age 22
Assumptions
Starting age 22
Retirement age 65
Life expectancy 85
Initial investment $0
Starting salary $30,000
Annual salary increase 3.5%
Annual Contribution 3%
Assumes investments during accumulation are made at the beginning of the year. Assumes withdrawals during retirement are
made at the beginning of the year. The successive slides regarding results of this hypothetical scenario assume a 6% rate of
return to retirement and then 4% from retirement until end of life expectancy. This case study is for illustrative purposes only and
is not intended to portray actual investment results. Each investor’s experience may vary.
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Consider Ernie
Newly Retired — Age 65 (Auto-enrolled at 3%)
Outcome: 10% Salary Replacement Ratio
Annual Contribution 3%
Ending salary at age 65 $132,000
Annual % investment returns 6.5%
Retirement savings at age 65 $343,000
4% annual withdrawal $14,000
Salary replacement 10%
Based on assumptions on slide 16.
Replacement ratio calculated as ending salary at age 65 divided by Ernie’s average annual withdrawals post-retirement.
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Consider Ernie
Newly Retired — Age 65 (Auto-enrolled at 6%)
Outcome: 21% Salary Replacement Ratio
Annual Contribution 6%
Ending salary at age 65 $132,000
Annual % investment returns 6.5%
Retirement savings at age 65 $686,000
4% annual withdrawal $27,000
Salary replacement 21%
Based on assumptions on slide 16.
Replacement ratio calculated as ending salary at age 65 divided by Ernie’s average annual withdrawals post-retirement.
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Help Participants Think of DC as an Income
Stream
• Translate account balances to annual income
• The numbers should:
– Be “real”
– Include future contributions and reflect inflation
• An employee who sees that his/her account balance
would only result in 30% replacement ratio may
decide to save more.
Employee Communications Should Project How Long Savings Will Last
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Drive Participation
• Profit-sharing contributions
• Stretch the match
• “Auto” plan services
• Organizational culture
Use These DB-Like Ideas to Boost Numbers in the Plan
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Adjust the Culture of the Organization
• Paternalistic approach
• Assume all eligible employees will participate
• Encourage “peer pressure” tactics
Assume a More Paternalistic Approach
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Priority: Reduce or Eliminate Leakage
Take Steps to Preserve Account Balances
401(k) Loan Activity
Percentage of participants who had loans outstanding at end of period
15.3%16.5%
18.2% 18.5% 18.2% 18.2%
2008 2009 2010 2011 2012 2013 (4Q)
Source: Investment Company Institute Survey of DC Plan Recordkeepers (December 2008–December 2013)
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Priority: Eliminate or Reduce Leakage
• Loans
• Hardship withdrawals
• Terminations – keep the funds in the plan
• Encourage roll-in for new eligible employees
• Services for past eligible employees and retirees
• Make it harder to get out
Take Steps to Preserve Account Balances
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Streamline the Number of Investment Options
Research Shows Having Too Many Options Paralyzes Participants
Conservative Aggressive
Risk
Tier IAsset allocation
Tier IICore building blocks
Capital
preservation
Global
bond
Diversified
inflation
Global
equity
Tier IIISpecialized
Self-directed
brokerage window
Target date
funds
Plan is hypothetical and for illustrative purposes only.
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QDIA
• Balanced
• Target Date
• Managed Accounts
Select and Evaluate Thoughtfully
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Investment Re-enrollment
Many Participants Do Not Know How to Invest
Plan Sponsor ABC
Data are hypothetical.
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Investment Re-enrollment
Hypothetical Plan (in millions of dollars)
Beforere-enrollment
Afterre-enrollment
Tier I Assets % of portfolio Assets % of portfolio
American Funds
Target Date Retirement Series®$40 13% $248 82%
Tier II Assets % of portfolio Assets % of portfolio
Vanguard Prime Money Market Fund $50 16% $10 3%
PIMCO Total Return Fund 20 6 4 1
Washington Mutual Investors FundSM
30 10 6 2
Vanguard S&P 500 Index 35 11 7 2
The Growth Fund of America® 45 15 9 3
EuroPacific Growth Fund® 60 20 12 4
CRM SMID Cap 20 6 4 1
Total $300 ~100% $300 ~100%
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Poll: Has Your Plan Done an Investment
Re-enrollment?
1. Yes.
2. Not yet, but it is scheduled.
3. We are currently discussing this topic.
4. We will put it on the agenda for discussion.
5. No, we are not likely to do this.
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Summary
• Risk sharing (aggregating) cannot be addressed.
• Other aspects can be addressed:
– Enrollment
– Saving enough
– Professional investment management
– Leakage
DB-izing Your DC Plan
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Poll: Can the Existing DC System Lead to
Successful Retirement for Participants?
1. Yes, if implemented to the fullest degree.
2. Maybe, with some tweaks.
3. No, cannot get there from here.
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Next Steps
• Auto-Enroll
– Adopt
– Implement, 6% or more
• Auto-Escalate
– Adopt
– Implement, 3% or more
DB-izing Your DC Plan
• QDIA
– Define
– Evaluate provider thoughtfully
– Conduct investment re-enrollment
– Streamline investment menu
• Affect Corporate Culture
– Encourage roll-ins
– Discourage leakage
– Encourage inactive participants to stay
in plan, especially retirees
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Investors should carefully consider investment objectives, risks, charges and expenses.
This and other important information is contained in the fund prospectuses and summary
prospectuses, which can be obtained from a financial professional and should be read
carefully before investing.
The statements expressed herein are informed opinions, are as of the date noted, and are
subject to change at any time based on market or other conditions. They reflect the view
of an individual and may not reflect the views of others across the organization. This
information is intended merely to highlight issues and not to be comprehensive or to
provide advice. Permission is given for personal use only. Any reproduction,
modification, distribution, transmission or republication of the information, in part or in
full, is prohibited.
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Investing outside the United States involves risks such as currency fluctuations, periods of
illiquidity and price volatility, as more fully described in the prospectus. These risks may be
heightened in connection with investments in developing countries. Small-company stocks entail
additional risks, and they can fluctuate in price more than larger company stocks. Lower rated
bonds are subject to greater fluctuations in value and risk of loss of income and principal than
higher rated bonds. The return of principal for bond funds and for funds with significant
underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate,
inflation and credit risks associated with underlying bond holdings. While not directly correlated
to changes in interest rates, the values of inflation-linked bonds generally fluctuate in response
to changes in real interest rates and may experience greater losses than other debt securities
with similar durations.
Investments in mortgage-related securities involve additional risks, such as prepayment risk, as
more fully described in the prospectus. Bond prices and a bond fund’s share price will generally
move in the opposite direction of interest rates.
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Questions?
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