Annuities Meaningless If Savings 'Practically Zero'
While some research suggests employees are willing to give up some financial rewards today in exchange for a secure retirement income tomorrow, few retirement plan sponsors are moving to offer annuities or guaranteed income options within their 401(k) plans.
Doug Fisher, SVP of thought leadership and policy development for retirement, health and welfare benefit issues at Fidelity Investments, discusses this apparent lack of interest on the part of plan sponsors and whether or not DC plans can deliver on long-term financial security for workers.
Can defined contribution plans really deliver on the promise of financial security in retirement for the majority of participants, the way defined plans did?
I believe we are at an inflection point. We're moving into the third generation of DC plans. The ability to use data and analytics to analyze workforce behavior, and incorporate the insights that come from that into plan design can help employees at all stages pre-retirees, mid-career and the millennials get on the right path to reach a reasonable level of financial security. Employers are shifting their focus from retirement asset accumulation to income replacement, which was the model for the traditional [DB] plan.
Is this leading many to incorporate annuity options into their DC plans, or facilitate participant purchases of annuities outside of the plan using rollovers at retirement?
We're not seeing employers in any great numbers saying, 'I want an income annuity or guaranteed income in the plan.' That may happen later. What we are continuing to focus on is employee participation rates, contribution amounts, and the investment design to ensure that any kind of guaranteed income will be meaningful. It doesn't matter whether you have an annuity or not if your savings are practically zero.
This raises the matter of participant financial literacy. Would it be helpful if regulators created detailed standardized definitions for specific investment choices that describe not only investment goals and strategies, but costs and transparency features?
Of course, simplicity drives understandability, and any time we can simplify the names of things, that helps. [Plan] sponsors, especially those larger employers that do custom funds, can pick the names that they want. But as for cost, that is usually a pretty minor factor in how things work out for the average employee compared to whether they're saving at the right level, and whether they are investing well to meet their goals.
Many sponsors believe that defaulting participants into a target-date fund is the way to go. But is that always true?
That is the core strategy for employers whose employees don't put the mindshare around investing. A lot of them just don't want to become investment experts. Maybe they'd rather play golf or read books or pursue a different hobby, and that's fine. But there's more to decide upon than whether to use target-date funds as the default.
We talk to employers about where they should set the initial deferral rate. Historically, many have set it at around 3%, but that usually is not enough when you do the math and project the income replacement ratios. So the first thing we do is ask employers to consider increasing the auto-enrollment to at least 6%. We'll say 'Can [you] phase it in, or just move it to 6%?' and always have a strong communication plan.
Some target-date funds only use passive strategies in their underlying investments. What approach does Fidelity take?
The components in our Freedom funds employ active management. For one thing, employers have different views of what the right benchmark might be, so just trying to match a popular index doesn't necessarily meet their needs. Also, we believe that the times when passive strategies perform well is cyclical. We feel we're going through a period of time now where active management may outperform passive, but there are also times when passive outperforms active. We have an open-architecture platform and can help employers decide which way they want to go.
How do you set the glide path of your TDFs?
We have literally tens of millions of investors, and we look at their retirement spending behaviors to help us make sure we have the right glide path. We can adjust it as needed based on what we see. For example, if participants aren't where they need to be with the assets they have accumulated at a particular stage, we might be a little bit less conservative. Our glide path five years ago was different from what it is today; we have a higher equity allocation closer to the target date.
We also incorporate our presumptions on how the markets will grow, changes in interest rates, and even mortality rates. Our asset allocation team looks at these and periodically makes adjustments to the glide path accordingly.
What are your thoughts on the most effective participation promotion techniques?
We're making big leaps in designing investment education and financial literacy for participants, using things that we discovered through insights from behavioral economics and our research. Different generations in the workplace are more receptive to certain kinds of outreach and education, than others. We are getting much better at customizing our like moment in time, our magic moment of engagement.
The first step is helping them [plan participants] with financial basics and developing that engagement, that trust and that understanding, and then the next message then starts with an appropriate level of savings.
We also know that as people get older, their receptivity to various kinds of financial education and messages change, including the way they receive the message, and we are starting to be better at applying that.
In the case of millennials, what sort of messaging strategy do you suggest?
When you have a young person going into the workplace, especially in an expensive location and possibly with outstanding student loans, they're going to have financial issues. Maybe they're thinking about buying a car, and eventually maybe a house. If we know that, our initial messaging might not be about saving as much as you can, but to help them to create a budget. And then if they get married, we'll have a better sense of helping them with family budgeting. Maybe they have children, so then that education funding becomes a greater priority.
What are your thoughts on the Department of Labor's proposed regulations for applying the fiduciary standard of care for people advising retirement plan participants?
The basic purpose of the proposal is to distinguish between basic financial education, and a guidance conversation that involves investment advice. That's where the DOL wants the fiduciary standard to apply. We agree with the underlying goal. But we're on the record saying that when we engage participants, we follow the suitability standard, which is a different standard. However, when we're helping participants understand their investment choices and needs, we have their best interests in mind anyway, whether or not we are held to a fiduciary standard.
The Department of Labor has proposed some very complicated rules that we feel are largely unworkable, given the practical realities of participant engagement. So we are working with the Department to modify the proposal so we can continue to provide the kind of investment guidance that participants want and need.
Richard Stolz is an Employee Benefit News freelance writer based in Rockville, Md.