By now, the move out of defined benefit plans into defined contribution plans has been well-established, although the success of the plans wavers with the strength of the economy.
In November, Fidelity reported its highest ever average balance in the 401(k) plans it administers, while in September, EBRI reported a drop in participation rates in employer-based retirement plan participation in 2010, after a steady increase since 2007. The Center for Retirement Research and the Urban Institute stated in a working paper released in November that participation rates increased “dramatically” to over 40% in 2001, then rose and fell in line with economic cycles.
Participants in 401(k) plans are “definitely influenced by the economy,” Barbara Butrica, senior economist at the Urban Institute and one of the authors of the Urban Institute/CRR working paper, told AdvisorOne on Monday. “We saw dips in participation and contribution amounts.”
Those dips are especially troubling considering contribution levels are already very low, she said. “Most people aren’t contributing anywhere near the limit.”
The working paper found median contributions increased over 19% between 1992 and 1999, and a much more modest 3.7% between 2002 and 2004. They fell approximately 5% between 2004 and 2007, and again between 2007 and 2009. The maximum contribution for workers in 2013 will be $17,500, the IRS announced in October.
“A lot depends on the economy going forward and whether income is increasing and how people feel in general,” Butrica (left) said Dec. 17. The Conference Board released its most recent Consumer Confidence Index in late November, showing consumers are slightly more optimistic than they were in October. The index now stands at 73.7.
Butrica said that the industry is still learning from the switch from defined benefit plans to defined contribution plans. “There are still a lot of things we don’t know about what it means for retirement security,” she said. “This is a very different world.”
She pointed to the increased pressure on workers in defined contribution plans to determine their retirement success. They have to decide whether to participate and where to invest their money, “decisions that formerly they didn’t have to think so much about. Many aren’t prepared to make the financial decisions defined contribution plans require.”
Patrick Lulley, vice president of DCIO and insurance sales for Van Eck, shares a similar perspective, but has identified a subset of DC plan participants who are eager (or at least willing) to make those financial decisions.
There are two major types of investors in defined contribution plans, Lulley told AdvisorOne on Dec. 14. The majority of investors are passive, and are interested in pre-diversified products like target-date funds and managed accounts. There’s a second group, however, of more sophisticated investors who want to take an active role in diversifying their portfolios.
These “diversify it yourself” investors are interested in non-traditional, non-correlated assets, Lulley (left) said, like commodities, emerging markets and real estate. They may only account for between 20% and 25% of investors, but Lulley said “the industry needs to recognize that they must help participants identify themselves” as DIY investors if they are going to plan successfully for retirement.
“It’s critical for advisors and sponsors in the educational meetings they have to first educate [participants] on the type of investor they are,” he said. “The majority doesn’t have the background to make informed decisions. [Advisors] have to make them comfortable with pre-diversified solutions that are professionally managed and have access to asset classes that are critical to diversified portfolios.”
Another trend Lulley expects to see in 2013 is the continued interest in the retirement readiness aspect of planning as boomers move into the decumulation phase of their retirement. “Insurers will develop products to support the ‘401(k) paycheck’,” he said.
“Some of the challenges for 2013 and beyond will be lower bond rates and stock returns,” Joe Tomlinson, actuary and financial planner at Society of Actuaries, said on Dec. 17. Overall, people may find they have to work longer and save more, and optimize what they get out of Social Security, he added.
“Looking at low-cost annuities is worth doing,” he said, in order for investors who are near retirement to share mortality risk. “Advisors need to have a conversation with their clients about long-term care,” he said, calling it the “biggest risk in retirement.”
One important trend in defined contributions should be an increase in “general investor education on the part of the industry,” Lulley said. “Participants are already seeing more information about their plans and the fees they’re paying,” he said. “Things like whether they’re on track to retire.”
Lulley expects plan sponsors’ move to outsource fiduciary services will also continue in 2013, especially regarding a plan’s lineup and investment selection.
Finally, advisors and plan sponsors have to communicate with participants in a way that they are comfortable with. “The industry is a little behind that curve and will have to respond in kind,” Lulley said. “People want to communicate in the way they like to communicate.” To Lulley, that means firms will have to adopt compliant ways to use Facebook, Twitter or email to get relevant information out to participants.
While many of the trends for 2013 are a continuation of trends that began in 2012 or even earlier, there is still a great deal of uncertainty surrounding the economy’s effect on defined contribution plans in the future. “We’ll know soon enough” what effect the fiscal cliff will have or what changes will be made to the tax nature of 401(k)s and defined contribution plans, Lulley said.
“It’s too early to tell what effect the new fee disclosure rule will have and whether it will drive participants toward low cost index funds,” Tomlinson (right) said. “We’ll have to wait and see.”
He added, “We’ve gone from looking at defined benefit plans where the risk was on the employer, to defined contribution plans where the risk is on the employee. We need to find creative solutions where that risk might be shared between the employee, the employer and the government.”
As examples, he pointed to projects like the SOA’s Retirement 20/20 initiative, which attempts to design a new retirement model based on input from industry experts, and Sen. Tom Harkin’s proposal to create privately run, hybrid pension plans to relieve some of the burden on employers, and to lift the cap on the payroll tax and expand Social Security benefits.
Lulley noted how much more important pensions and private savings are in light of “the national debate over the funding and solvency of Social Security.”
“We all react to market gyrations, but diversification is very important. We need to have some ability to construct portfolios ourselves.”
Butrica suggested advisors talk with their clients about the Social Security benefits they can expect. “Show the math,” she said, that demonstrates what happens if they take benefits as early as they can or if they continue working. It’s also important to show the impact their decision will have on others. “If they have a spouse, their decision will affect future widow benefits.”
Butrica noted that awareness about the role Social Security should play in a retiree’s income is “moving in the right direction, but we’re not there yet.” She said, “Social Security was never meant to be a retiree’s sole income. It’s supposed to supplement pensions and private savings. People are slowly getting on board, but many more people need to understand that.”