February 6, 2012

Defined-Contribution Plans ‘Primary Retirement Savings’ Tool for Young Workers

Uncertainty about Social Security, limited access to pension plans mean young workers will depend heavily on DC plans

Workers under the age of 35, the generation most likely to depend almost solely on defined-contribution plans rather than the typical Social Security-savings-pension three-legged model, need to be diligent if they expect to save enough for retirement, a report released in October by Northern Trust found.

Lee Freitag“Sponsors have to engage younger workers to save, save a lot, and to continue saving,” Lee Freitag (left), product manager of defined contribution solutions for Northern Trust, told AdvisorOne on Monday. To that end, sponsors need to limit loans to prevent leakage. Educating workers to avoid taking loans from their retirement plans is a “smart thing to do.”

The report, “The Path Forward,” was conducted by Greenwich Associates and is part of a research series on defined-contribution plans. Greenwich Associates interviewed 45 plan sponsors representing 1.5 million participants and over $175 billion in assets.

The report found that most plan sponsors agree the primary objective of a DC plan is to help employees save for retirement, but acknowledges that much of the industry’s focus in the past 10 years has been on baby boomers.

While about 60% of sponsors say they are confident that their clients’ plans will prepare them for retirement, less than half of DC plan consultants surveyed agreed. One reason for that, the report found, is that most plan sponsors have never set specific goals for different age groups in their plans. Setting goals and targeting different age groups is a “critical step” in increasing plan effectiveness, the report found. Younger investors, though, have three characteristics that make creating a targeted plan difficult:

  • Young investors lack discipline and often keep low savings rates
  • They have difficulty staying engaged with a savings plan over a long period of time
  • They lack a basic understanding of investing

Furthermore, young investors are more likely to cash out a retirement plan when changing jobs.

The younger generation may not have suffered as much in the recession as older workers who saw their retirement savings evaporate just a few years before they expected to retire, but they haven’t come out unscathed. The report notes that unemployment rates for young Americans are at historic highs, and plan sponsors reported difficulty convincing young workers to save for retirement when they may be suffering more immediate cash needs.

Northern Trust sees a silver lining in the timing of the recession for young investors, though, comparing them to the generation that survived the Great Depression. “Though young workers today may be financially or psychologically supported by a social safety net, they are likely to carry these memories and lessons with them for the rest of their lives. If these workers follow the example of many who lived through the Great Depression, they might demonstrate a life-long appreciation for the value of financial security. This perspective could manifest itself through higher savings rates and higher participation rate in company-sponsored DC plans, as well as greater engagement levels in managing their plan accounts and other investments.” Furthermore, young workers have time to make up the losses they suffered.

In their action plan for engaging young investors, Northern Trust highlighted actions that could be taken in the near term, medium term and long term with varying degrees of effort on the part of sponsors. Among the immediate actions sponsors can take with a minimal investment is to begin setting goals and measuring progress by age group. Sponsors should develop targeted marketing and education programs, and take steps to prevent workers from cashing out their retirement plan when they change jobs.

In the medium term, sponsors can increase their use of automatic features and increase deferrals to 15% over time. Re-enrollment programs where participants’ allocations are periodically reallocated to QDIAs can help diversify their holdings.

In the long run, sponsors may not have much control over changing young investors’ habits and characteristics, but the report encourages sponsors to work toward reforming counterproductive regulations. For example, legislators should re-examine restrictions on pre-tax contributions, according to the report. Since young workers are more likely to change jobs frequently than old workers, disallowing distributions immediately after a job change can help keep money in a retirement account longer.

Finally, sponsors should not ignore technology. “Industry participants ranging from recordkeepers to investment managers and advisors should be making better use of technology in a concerted effort to reach young workers,” according to the report. Sponsors need to adopt mobile technology, social media, online tutorials, plan participation simulators and other Internet-based methods for delivering education and plan information. 

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