With pension plans headed for virtual extinction, the 401(k) will inevitably become the sole qualified retirement savings vehicle in the nation, and as such, the defined contribution model must be vastly improved, speakers at the Investment Company Institute's General Membership Meeting in Washington said.
Indeed, a milestone for 401(k)s was reached last week, when consulting firm Watson Wyatt revealed that more than half of Fortune 100 companies now offer only a 401(k) plan, the first time the majority of the nation's 100 biggest companies aren't offering a pension plan.
With the retirement savings burden falling increasingly on individuals, then, 401(k) plans must increase participation and savings rates through yet more preset features beyond automatic enrollment, such as escalated savings and target-date funds. To date, however, only 50% of employers that offer 401(k) plans on Fidelity's platform use automatic enrollment. While that covers a majority of the people in Fidelity's 401(k) plans because auto enrollment is primarily used by large companies, there is obviously room for more growth.
Beyond auto enrollment and auto step-ups in contribution rates, speakers said, 401(k) plans must also include income options, withdrawal strategies, education, advice, modeling tools and clearly disclosed fees.
"Automatic enrollment has been one of the greatest innovations for 401(k)s," said Scott David, president of workplace investing at Fidelity. "Fifty percent of our sponsors use this, boosting participation from 60% to 90%. And 90% of employers using automatic enrollment use target-date funds as the default."
"Automatic increases are every bit as important as automatic enrollment," added Barbara Fallon-Walsh, a principal with Vanguard, who pointed out that if the contribution rate at inception is moved up to 4% or 5% as opposed to 3%, that prompts very few people to opt out.
The years of holding on-site enrollment meetings at plan sponsors are now paying off, with most people understanding the basic tenant of investing through a 401(k), said Cynthia Egan, president of T. Rowe Price Retirement Plan Services. "Now that participants are in the plan, we have a new opportunity to provide financial literacy. To date, they are savers, not investors. They also need to learn about retirement income," she said. "We need to modernize and shift much of our communication."
Daniel J. Houston, president of retirement and investor services at Principal Financial Group, agreed that 401(k) plans should help people plan for their years in retirement with products that address longevity risk and inflation risk. And somehow, the industry must figure out a way to offer 401(k) investors "tailored solutions" and a "withdrawal strategy" because, Houston said, every investor has different needs and goals, and "there is no silver bullet."
Houston noted that with the average wage in the U.S. at $40,000 a year, people need to save 13% to 14% of their earnings in order to be prepared for retirement. But the fact is, Houston said, "the average savings rate is half of what it needs to be. When the 401(k) becomes the retirement savings vehicle, there is no question that we will have to fix that."
David said tailored retirement savings and income solutions will arise through "increased product development to meet the needs of Baby Boomers."
In addition, David added, "our industry communication has to switch from participation to event-driven, based on life events."
Investors are now looking for guaranteed income streams in retirement, yet they resist losing the flexibility of having access to their money by irrevocably handing their money over to an insurer in an annuity, Fallon noted. Thus, if the industry could offer investors "greater flexibility with an immediate annuity, that would be more appealing," she said.
In fact, while investors say they like having access to their money and a variety of investing choices, "a large percentage wants to delegate investment decisions and want the sponsor to handle it," Egan said.
Thus, she suggested, perhaps the way to modernize 401(k)s is simply "to take people by the hand through automation, simplification and education and to restructure 401(k) plans so that the lineup is all target-date funds with a brokerage window."
The emphasis on automation throughout the conference was probably why so many speakers touted the value of target-date funds, even in the face of 2010 funds faring so poorly in 2008; the average 2010 target-date fund lost 25% of its value, with one fund even plummeting by 41%.
Putnam Investments CEO Robert L. Reynolds said that the percentage of stocks that target-date funds hold should be regulated by the Securities and Exchange Commission, particularly as target-date funds near the retirement date.
Reynolds also supports the controversial fee-disclosure legislation, introduced by Rep. George Miller (D., Calif.), chairman of the House Education and Labor Committee. Speakers at the ICI conference said they, too, would embrace better fee disclosure, although David warned "it's a complicated apparatus," and some speakers feared that investors might misuse the information and move too much of their portfolios into low-cost, highly conservative choices.
Houston also pointed out that disclosing fees is an additional cost. "Who would cover the cost?" he asked.
Repeatedly, too, speakers said that financial literacy and third-party education and advice will become more pervasive in 401(k)s, with many believing that personal finance should even be a mandatory subject taught in subject.
On the subject of regulation, David said there are so many different rules covering 401(k)s, 403(b)s, 457s, IRAs and Roth IRAs. "Defined contribution is the primary savings vehicle, and we must simplify regulations," he said.
And with 401(k) plans offering more conservative and income-generating solutions, said James ("Jes") Staley, CEO of J.P. Morgan Asset Management, "we need to be very wary of how we identify products, such as enhanced cash, which is an oxymoron, and absolute return, which can still generate a negative return."
Financial models will also need to be updated, since speakers believe that investors' current aversion to risk could continue for many years to come, and in this "deleveraged world," a good annual compound rate of return will be between 5% and 7%, as opposed to the historical 10% stock market return.
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