Recent advances in defined contribution plans have markedly boosted workers’ retirement savings. But the jury is out on whether such changes will be enough to close a continuing retirement savings gap, and whether employers are prepared to offer supplemental retirement benefits that might expose them to greater fiduciary and legal liability.
These were key points made during a wide-ranging panel discussion hosted by Prudential Financial on Tuesday. Titled “2015 Global Economic and Retirement Outlook,” the 6-person panel — John Praveen, Quincy Krosby, Michael Lillard and Srinivas Reddy of Prudential, Edward Keon of Quantitative Management Associates and moderator Ron Insana, a contributor to CNBC and MSNBC — prognosticated on macroeconomic and market trends that will impact the insurance and financial services industry in the year ahead.
Closing the retirement gap
Respecting retirement security, Srinivas Reddy, a senior vice president and head of full service investments for Prudential Retirement, said that more companies are implementing target date fund strategies as default investment options. Target date-based mutual funds automatically adjust the equity/fixed income allocation of a plan participant’s portfolio to be consistent with an employee’s age and risk tolerance.
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Reddy noted, too, that employees’ tolerance for high default plan participation rates is greater than once believed. Whereas a few years ago the assumed cap on such rates was 2 to 3 percent, plan sponsors have since learned that default rates can be set at 8 to 10 percent without adversely affecting “opt-out rates” (i.e., the percentage of employees who opt out of a plan or elect to contribute a percentage of compensation different from that automatically set by the company).
A Prudential report co-authored by Reddy and distributed at the event, “Guaranteed Lifetime Income and the Importance of Plan Design,” observes that defined contribution plans with “IncomeFlex” — Prudential’s guaranteed lifetime retirement income benefit — boasts lower opt-out rates (3 percent less) than do plans that don’t offer in-plan guaranteed retirement income.
When coupled with auto enrollment, plans offering a retirement income guarantee also enjoy higher plan participation rates than do plain-vanilla DC plans (87 percent vs. 65 percent, respectively). They also claim higher contribution rates (8.4 percent vs. 7.8 percent); and a lower percentage of non-diversified investors who allocate 100 percent of their portfolio to equity or fixed income funds (8 percent vs. 24 percent).
But given the continuing gap between workers’ savings rates and the nest egg needed to secure a lifetime retirement income, industry skeptics question whether advances such as auto enrollment, target date funds and annuity-like guaranteed income benefits will enough to close the gap.
Might supplemental retirement benefits — hybrid plans that combine elements of defined benefit and defined contribution plans, profit sharing plans that give employees an equity stake in their businesses or employee-owned cash value life insurance policies — be needed to close the retirement gap? And if so, are most businesses willing and able to offer such benefits?
During a Q&A with attendees, Prudential’s Reddy said that companies will offer the benefits necessary to recruit and retain qualified talent. But he cautioned that plan sponsors remain wary of offering retirement benefits that might impose a fiduciary responsibility on them to guarantee such benefits — thereby increasing their legal liability.
What investment yields are retirement savers likely to generate on their investments in the year ahead? Edward Keon, managing director and portfolio manager of Quantitative Management Associates (QMA), said that lower returns should be expected across all asset classes in 2015.
“In the current investment environment, a 5 percent yield is a very nice return, particularly given fact that inflation rate is likely to stay low for a very long period of time,” said Keon. “An earnings yield of 6 to 7 percent on equities [adjusted for inflation] is roughly what we can expect over the long run. That’s below historically high equity returns of 10 percent-plus, but compared to current bond yields of less 2 percent, the higher equity yield looks pretty good.”
Keon added that QMA remains more bullish on U.S. stocks than international stocks. While noting that shares of many European companies are now selling at “multiples far below” shares of comparable U.S. companies, it would premature for investors to transition to international equity because U.S. stocks enjoy higher yields and growth potential.
Yet, current returns on U.S. stocks are below historical rates — most especially those of the early dot.com era. Keon attributed this partly to depressed growth rates for GDP and labor force participation relative to prior decades.