It’s no secret that employers over the last decade have been increasingly rethinking their retirement offerings. Whether it’s to reduce overall retirement costs, respond to new regulations or react to changing market pressures, plan sponsors across the country are steadily replacing the defined benefit plan of the past with the defined contribution plan of the present. Out with the DB, in with the DC. The consequences of that shift are significant.
Essentially, DC plans transfer the capital accumulation responsibility from the employer to the employee. Participants in a DC plan are tasked with deciphering personal retirement goals, implementing a savings and investment plan around those goals, monitoring progress toward those goals and distributing savings prudently over the course of retirement. Since the plan could be the primary source of retirement income for the participant in the years to come, the importance of effectively executing on these responsibilities cannot be overstated.
The plan sponsor’s role, meanwhile, is basically to augment the participant’s chances of success by paying careful attention to plan structure, component investment options, oversight and robust education. The good news is that sponsors of plans large and small appear to be stepping up to this challenge by engaging more third-party financial expertise and increasing plan governance. Even large plans with access to human resources, in-house counsel, treasury and other support appear to be increasingly outsourcing the fiduciary oversight role, as reported in PIMCO’s DC Practice report earlier this year.
DC Plans Take Aim
A good deal of what’s behind that transition can be traced to two important events: The implosion of Enron in 2001 and the passage of the Pension Protection Act (PPA) in 2006. For its part, the Enron meltdown not only resulted in the ultimate passage of Sarbanes-Oxley, it immediately suppressed the use of a company’s stock within its retirement plan offerings. As a result, plans up and down the spectrum began to promote the diversification of investment risk through mutual funds and other pooled vehicles.
Then PPA came along with its Qualified Default Investment Account (QDIA) designation. The Act, passed when many plans had participation rates as low as 50%, led to a good deal of automatic participant enrollments flowing straight into Target Date Funds. In short order, target date investment options migrated from what had been the exclusive realm of the institutional plan to a much broader audience.
And with good response. Vanguard and Fidelity, the two largest retirement services providers in the country, report target-date adoption rates are still rising at the participant level even as plans increased the overall number of funds offered. (See Vanguard’s How America Saves– 2011 and Fidelity Investments’ Building Futures Volume VIII) This dichotomy likely stems from the desire for flexibility from participants juxtaposed with the sponsor’s desire to mitigate risk and provide the most prudent solution for goal achievement.
Neither Straight Nor Narrow
Target date funds typically offer the benefit of some kind of professionally implemented portfolio theory coupled with the ability to access asset classes like commodities and emerging market debt. And by definition, they come with a glide path, i.e., a formula that defines the allocation mix based on the number of years to the target date. When analyzing target date funds, it’s the glide path that requires the greatest burden of scrutiny.
In practice, the glide path creates an asset mix that becomes more conservative as the fund gets closer to its target date. Understanding this mix before and during the distribution phase is crucial to knowing where the most significant risk to participant retirement goals lies. For example, a number of 2010-dated funds maintained relatively high equity exposure in 2007 just before the market crash in 2008. The result was significant declines for investors planning to retire in 2010.
The experience of 2008 notwithstanding, Target Date Funds have seen, and are still seeing, significant adoption. In fact, the most recent EBRI/ICI 401(k) data indicate that a third of 401(k) participants in its universe held target date funds. Looking ahead a bit, Brightscope, a provider of retirement plan ratings and investment analytics, projects in its Real Facts About TDFs report that by 2020 Target Date Funds will make up one-third of all retirement assets and represent the number-one savings vehicle in America
Still Seeking the Holy Grail
At this hour, the obvious vacancy in defined contribution plan lineups is an income distribution solution that doesn’t require an out-of-plan insurance product conversion.The so-called ‘decumulation phase’ has garnered a lot attention, but no one’s yet to discover the way to build a truly seamless continuum of sponsor-aided retirement savings. The search, in other words, for a single-product solution continues. We look forward to seeing what creative ideas will be introduced by eager product innovators.