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Retirement Planning > Saving for Retirement > 401(k) Plans

4 Major Themes That Will Shape the DC Retirement Market in 2023

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What You Need to Know

  • Provisions included in the Secure Act sparked a wave of lifetime income product innovations, leading to increased cost and complexity.
  • Managed account utilization is on the rise and rapidly evolving, offering the ability to customize a participant’s portfolio.
  • Increasing complexity has led a growing number of plan sponsors to outsource investment design, selection and monitoring responsibilities.

The U.S. private defined contribution (DC) market is evolving from a supplemental savings vehicle to a primary retirement vehicle, supporting employees throughout their retirement. This shift, along with major retirement legislation, is leading to innovations that address retirement readiness as well as longevity risk.

To stay relevant, plan sponsors and their advisors must evaluate the latest market trends and developments to ensure that they continue offering competitive retirement benefits that meet the diverse needs and expectations of their employees and retirees.

1. Need for Inflation Protection

Inflation, both domestically and abroad, remains stubbornly high. While inflation will likely decline due to the Federal Reserve’s monetary policy and as transitory issues impacting supply chains are resolved, we expect it will remain elevated relative to the level experienced in the decades before the pandemic.

In such a scenario, asset class correlations may be less diversifying than they have been in the past, as traditional stock and bond portfolios tend to do poorly amid high or rising inflation, this calls for the following considerations:

  • Supplement core investment options utilized by “do-it-myself” participants with a multi-asset inflation hedging option with exposures diversified across a basket of real assets such as REITs, TIPS, commodities and gold. These assets respond differently to inflation depending upon the specific inflationary drivers, enhancing diversity relative to a traditional stock and bond portfolio. Managed accounts can be helpful with the appropriate sizing of the allocation to real assets.
  • Annuities can be used as a replacement for a portion of traditional fixed income allocation to enhance income and protect retirees from an income “tail risk” in an environment, like today, where bonds underperform and produce negative real returns after accounting for inflation.Annuities are expected to play a more prominent role as part of professionally managed allocations, as the industry moves to address common challenges associated with retail annuities.

2. Evolution of Lifetime Income Solutions

Lifetime income products have been available for DC plan sponsors for some time, but participants’ utilization has generally been very low. The passing of the Secure Act in 2019 provided fiduciaries new safe harbor provisions when selecting an insurance provider and gave participants new portability provisions that allowed them to transfer a 401(k) annuity to a different workplace plan or IRA without paying surrender charges and penalties.

This has spurred an unprecedented wave of product innovation, including embedding annuities as part of target date funds with the option — not the obligation — to annuitize a portion of a participant’s balance.

This approach builds on the success of target date funds as the Qualified Default Investment Alternative (QDIA) and would likely lead to higher annuitization rates. Additionally, a plan sponsor would benefit from delegating the fiduciary duty of selecting and monitoring the insurance provider as this role would be undertaken by the target date fund provider.

An alternative approach is to offer in-plan annuities on a standalone basis and pair them with a managed accounts program that can help participants determine the optimal amount of annuitization. Managed accounts are rapidly evolving to account for guaranteed income offerings and have an advantage over target-date funds through their ability to customize a participant’s portfolio and level of annuitization based on their specific financial circumstances and objectives.

Participants closer to, and in, retirement are more likely to engage with managed accounts and have a higher need for personalization.

Plan sponsors will need to be aware of the increased cost and complexity associated with the lifetime income products, along with myriad other considerations. Recordkeeper integration and participant experience will be key to the success of the program.

Currently, the portability of these solutions between recordkeepers is limited; however, this is expected to change as the middleware infrastructure between plan sponsors, recordkeepers and insurance providers is further developed.

3. Rise of Personalization

The adoption of managed accounts has been on the rise as plan sponsors look to provide a more personalized service to their participants, especially those nearing retirement. Managed accounts use low-cost, institutionally priced investment options made available by a DC plan and offer sophisticated financial planning capabilities at half the cost of a financial advisor.

Fully reaping the benefits of the managed accounts service requires participant engagement, including additional information not currently captured by the recordkeeper. Otherwise, these accounts risk becoming a more expensive target date fund.

The utilization rate by participants, however, has been low so far, driven by the lack of awareness that such benefits exist. Aside from greater communication efforts to elevate awareness, another way to drive adoption is to implement a dynamic QDIA, which is a default option that starts a participant off in a target date fund and automatically transitions (unless they opt out) into managed accounts once certain triggers for transition are hit.

The growing interest in dynamic QDIA solutions from plan sponsors is expected to continue, especially as managed account program fees continue to compress and managed account offerings evolve to support participant retirement income objectives.

4. Demand for Outsourced Investment Management

The complexity of the DC world is exploding. Plan sponsors and fiduciaries are required to navigate the landscape of changing rules and regulations, litigation risk, market volatility, rapid investment product evolution and a host of other challenges such as shifting workforce demographics.

For many organizations, there’s a lot to keep track of with limited internal resources. In response, a growing number of plan sponsors have elected to outsource investment design, selection, and monitoring responsibilities to an ERISA 3(38) Investment Manager, also known as an Outsourced Chief Investment Officer (OCIO) — a trend we expect to accelerate.

Outsourcing intends to drive better outcomes, including lower investment fees for participants, improved investment resources and oversight, and reduced administrative burdens for the plan sponsor. This gives plan sponsors more time to focus on strategic initiatives and ongoing fiduciary education.

Outsourcing investment oversight and implementation to a prudent third party can also potentially help manage fiduciary risk. As part of a prudent fiduciary process, plan sponsors should evaluate the merits of this alternative governance approach and weigh them against the cost of OCIO.

Julija Kod is senior vice president, investment consultant, with Wilshire Associates, and Nathan Palmer is a managing director and principal at Wilshire Associates.

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