Auto-features and financial wellness seem to dominate industry headlines these days. To be sure, innovations such as auto-enrollment, auto-escalation and age-based default investment alternatives have benefited millions of participants. But noticeably absent from much of the headlines are initiatives to better serve the group of participants who are preparing or ready to spend their hard-earned retirement savings.
We refer to this cohort as the pre-retirees and retirees in our defined contribution plans-or simply, participants over 50. Over 60% of DC plan assets reside with these individuals.1 And yet most plans lack the investment options, planning tools, and even plan document provisions that can make the plan truly work for them in retirement.
At Franklin Templeton, we believe that one of the next areas of innovation in the DC industry should be the development of a “Retirement Tier”. A great deal of retirement income options exist that can help households fit the DC plan into the context of their complex and unique retirement strategy. We think it’s critical that these investment options are accompanied by retirement-oriented tools and advice, retirement-friendly plan design/document provisions, and targeted communications that can help this group. And in fact, many plan sponsors have already started down this path, perhaps without recognizing it.
WHAT THE DATA TELL US ABOUT PARTICIPANTS APPROACHING RETIREMENT
As an industry, we often take a simplified view of participants as being generally disengaged and unresponsive to communication and education. We believe these assumptions are worth challenging, particularly with regard to the population over 50 that tends to face increasingly complex and unique financial situations as they approach retirement.
PARTICIPANTS OVER 50 HAVE MOST OF THE ASSETS
DC Plan Assets by Age Group
Default Options Become Less Popular with Age
The interaction between tiers in a DC menu and how participants personalize their asset allocation to their unique household situation is in-line with recent research conducted by Financial Engines. In that study, they found that 89% of participants already use other investment options in conjunction with target-date funds (TDFs). In addition, 54% of the participants who have changed their asset allocation from the default said that they did so because the TDF was either too risky or not risky enough for their needs.2
Financial Contexts Become More Complex and Varied
When we consider auto-enrollment and how to set new hires on a path to a financially secure retirement, we often take an overly simplified view. We view them as young, single, and lacking any other sources of retirement income. But in reality, most new hires have been in the workforce for some time, and they’ve likely already been participating in a DC plan prior to their new employment. Additionally, they may have additional financial resources, including those of a spouse or partner, that they would include in their retirement calculation. A more appropriate way to view DC participants is through a longitudinal lens—recognizing that their current plan assets may only be a snapshot in their broader retirement savings history.
Viewing through this broader lens, it becomes clear that DC participants nearing or in retirement are a very heterogeneous group with complex needs. The move to simplify menus and rely on automation does not apply so well in this context. These participants are looking for help with how to fit their current DC plan in the context of their entire, unique, household financial situation.
A More Engaged Participant
Participants over 50 years old tend to be much more engaged than conventional wisdom suggests. A recent Franklin Templeton study shows that 91% of DC plan participants over 50 check their balances at least annually.3 62% reported rebalancing or making changes to their portfolios at least annually. Finally, 52% of the individuals we surveyed said they actually preferred to self-manage their DC investment options. These findings reflect that this group is paying attention, prefers to be involved and wants to be informed. This is likely due to their proximity to retirement and the complexity of their unique financial situations. In our assessment, this group is much more open to utilizing in-plan tools and responding to targeted, relevant communications.
THE THREE-TIERED PLAN, REVISITED
The concept of “tiers” is familiar to most DC industry professionals. It helps us organize our approach and in-plan offerings to meet the needs of different types of participants. We use a number of different category labels and terms in the industry when it comes to tiers, but they all paint a similar picture. DC plans are made up of a range of investment options, tools and features intended to meet the needs of different participant groups with varying levels of engagement. The graphic below helps clarify what makes up a traditional three-tier plan, by our definition.
INTRODUCING THE “RETIREMENT TIER”
We believe that DC plan sponsors, consultants and advisors ought to expand the common notion of the three-tiered investment menu and start incorporating a Retirement Tier into their DC plans. Unlike other tiers in the DC plan, our view of a Retirement Tier is a more comprehensive set of complementary solutions that are targeted for participants nearing or in retirement.
A Retirement Tier is a set of carefully chosen investments, tools and advice that can help pre-retirees and retirees execute a strategy to fit their DC plan into the context of their overall household financial situation. It also serves participants that identify with any of the three traditional tiers, and is complementary of the other tiers in the menu.
While every in-plan option must be available to all participants, components of a Retirement Tier can exist in a separate section of the record keeper’s web portal, and targeted communications can drive participants over 50 to it.
Characteristics of the Retirement Tier
A key characteristic of the Retirement Tier is that it’s not mutually exclusive with the rest of the plan.
Rather, we see the Retirement Tier as a piece of the overall DC puzzle (and by extension, the household retirement mosaic). It should work hand in glove with what’s currently available in the rest of the plan.
When an individual gets to the point where they need more specialized tools and investment options, the Retirement Tier serves as that outlet.
Another key characteristic is that there is no single, one-size-fits-all solution. There can’t be. Participants’ circumstances and preferences diverge with age, and different options are necessary to meet different needs. Moreover, the tier is complementary and should serve all types of participants that identify with each of the three main tiers. Multiple options-for instance, both flexible and guaranteed income solutions-can better meet the needs of more participants.
Components of the Retirement Tier
The concept of a Retirement Tier goes beyond the investment menu to help increase the utility of the investments. The three other components of a high-functioning Retirement Tier are plan design changes, targeted communication programs, and tools and advice geared to help educate participants and assist them in planning and executing their retirement strategy.
1. Tools and Advice
DC plans are embracing the idea of financial wellness, with the introduction of engaging tools that help participants with financial challenges broader than just 401(k) investment decisions, such as how to pay down student loans. But most of these planning and education tools are geared toward younger participants. A Retirement Tier would further extend this concept to tools that are specifically useful for the group of participants nearing the end or already at the end of their careers, such as a Social Security Optimizer.
2. Targeted Communications
One idea for targeted communication plan sponsors could send to participants when they turn 62 is to educate them on the potential benefits of delaying Social Security. They could use the opportunity to introduce them to a Social Security Optimizer tool as well. Because we know this group is much more engaged, they are more likely to positively respond to the communication, thus helping them be prepared to make more informed and strategic decisions around how and when to file for Social Security benefits. This would have a tremendously positive impact on how households then manage their 401(k) assets.
3. Investment Options
In the event that a participant in a DC plan, in the context of what’s best for their household, makes the decision to delay Social Security benefits, that household may need to figure out how to fund their retirement from the time they retire to the time they start receiving benefits. That is why it’s essential that an effective Retirement Tier have investment options that satisfy the needs associated with a wide range of circumstances.
An investment option designed to provide more cash flow predictability while still earning income would be a logical solution. A “laddered” series of defined maturity bond funds could allow the participant to “sequester” savings needed to meet household expenses, and provide the necessary income until Social Security begins. Other investment options that could be part of the Retirement Tier are managed payout funds, inflation protection funds and insurance based products such as guaranteed minimum withdrawal benefit (GMWB) contracts or qualified longevity annuity contracts (QLACs).
4. Plan Design
Finally, there are many plans that have plan documents with provisions that are either outdated or in conflict with what plan sponsors state as their goals for the plan. For example, 69% of plan sponsors agree that participants should leave their assets in the plan and allow them to drawn down over time.4 However, only 13% of DC plans allow terminated participants to take ad-hoc, partial distributions from the plan.5
A Retirement Tier can help make the plan serve the needs of participants at all stages of the plan, and nudge them toward an on-time, financially secure retirement. Many plan sponsors have already taken steps on this path and each new in-plan investment or tool, plan design change or targeted communication that helps participants over 50 is another step toward a robust Retirement Tier. It can and should look different in each plan, as plan sponsors make enhancements to their plan to better serve their own participants’ needs. Approaches will differ, but the shared goal should be to make DC plans work for participants, all the way through retirement.
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- Source: Employee Benefit Research Institute and the Investment Company Institute, as of December 31, 2014. Most recent available data.
- Source: Financial Engines, “Not So Simple: Why Target-Date Funds Are Widely Misused by Retirement Investors”, March 2016.
- Source: The Franklin Templeton In-Plan Retirement Income Web Survey was a 15-minute online survey administered during March 2015. All 455 respondents were working (full-time or part-time) or previously worked for a large employer (1,000 employees or more), with at least $100,000 in DC plan balances (including current or former plans).
- Source: The Cerulli Report, “U.S. Retirement Markets 2014: Sizing Opportunities in Private and Public Retirement Plans,” Cerulli Associates. Only plan sponsors to plans with over $100 million in DC assets were surveyed.
- Source: “Retirement distribution decisions among DC participants-An update,” Vanguard, September 2015.