The Markets July 13, 2007

Next Generation of Lifecycle Funds Offers Improvement

Advisers should not view the prevalence of lifecycle funds as a threat to their business, said Barbara J. Best, Vice President, Investments, Capital Strategies Group of Wachovia Securities; “we need to focus on what is best for participants instead of [on] egos.″
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Although first-generation fund offerings were primarily a mix of a provider’s proprietary investment lineup, the next generation of asset allocation funds include other providers’ funds, as well as a wider variety of asset classes, said a panel at PLANSPONSOR’s recent Plan Designs conference.

Second generation products look more like a defined benefit structure, and these new funds offer great opportunities for advisers focused on the outcome of a retirement plan as a whole, commented Matthew Mintzer, managing director, AllianceBernstein. The move to include other provider’s funds in the lifecycle option is necessary Best said because there is no one organization that can be the best in all asset classes.

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The expansion into a more defined benefit format is attractive for retirement plans, said adley Leak, Senior Manager, Investment Strategy & Asset Allocation at Boeing. When Boeing investment officials wanted to add a lifecycle option to their plan in 2005, they looked to providers for a lifecycle option in which the underlying funds held a variety of alternative investments; the company specifically asked for REITs, emerging market equities, commodities and Treasury Inflation-Protected Security (TIPs).

However, what might be best for the adviser and participant is not always so for the recordkeeper, who might be resistant to include outside funds in their own fund, thereby driving money away from their firm. Further, recordkeepers who sometimes resist a plan’s request to host a target date fund made up of someone else’s offerings, Best warned.

Fees continue to be a big issue surrounding lifecycle funds, because many of the lifecycle fund offerings apply an overlay fee to the underlying funds, which all have their own varying expense ratios, said Joseph Nagengast, President of Turnstone Advisory Group. This overlay is legitimate if the underlying fund is made up of nonproprietary funds, because it covers the expense of mainting the fund. However, if the fund is all proprietary funds, and the expense ratios are all going back to the recordkeeper, why should the plan sponsor and participant be paying extra, he asked. However, “While we have our eyes on the fees,’ Best said, “that doesn’t drive our decision.’

Even though most providers say they offer an open architecture platform, that’s not really the case when it comes to lifecycle funds, according to Best. Therefore, advisers and their plan sponsor clients sometimes must push the provider to include non-proprietary funds on their platforms. Not all sponsors can achieve this, but if a $100 million plan or larger asks for the new funds, the provider is more likely to acquiesce, she said. “We have to choose when and how hard we push,’ Best said. “That [discussions with recordkeepers] is where the push has to come from.’

However, Mintzer said he thinks the consolidation in the recordkeeping space has left the remaining players more open to client demands in order to keep the business. But a little friendly persuasion still can’t hurt. “Stepping up and making that demand will help change it for everyone,’ Mintzer asserted.

Data & Research July 13, 2007

Federal Laws Don’t Offer Clarity on Retirement Age

Workers who are confused about when to retire cannot look for clarity from Social Security, Medicare, and pension laws, because those three groups offer conflicting incentives to retire earlier or later than the traditional retirement age.
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A new report from the Government Accountability Office (GAO) pointed out the availability of reduced Social Security benefits at age 62 provides an incentive to retire before the program’s age requirement for full retirement benefits; however, the gradual increase in this age from 65 to 67 provides an incentive for workers to wait to secure full benefits. In addition, the elimination of the Social Security earnings test in 2000 for those at or above their full retirement age also provides an incentive to work.

Medicare’s eligibility age of 65 continues to provide a strong incentive for those without retiree health insurance to wait until then to retire, but it can also be an incentive to retire before the full retirement age, the GAO study concluded. Finally, federal tax policy creates an indirect incentive to retire earlier by setting broad parameters for the ages at which retirement funds can be withdrawn from pensions without penalty.

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The GAO found in its study that nearly half of workers report being fully retired before turning age 63 and that they have started drawing Social Security benefits at the earliest opportunity – age 62. However, evidence suggests small changes in this pattern now. Traditionally, some workers started benefits when they reached age 65, but recently, workers with full retirement ages after they turned 65 waited until those ages to start benefits, according to the report. Also, following the elimination of the earnings test, some evidence shows increased workforce participation among people at or above full retirement age.

Retiree health insurance and pension plans are strongly associated with when workers retire, according to the GAO analysis. After controlling for other influences such as income, GAO found that those with retiree health insurance were substantially more likely to retire before the Medicare eligibility age of 65 than those without. Men with defined benefit plans were more likely to retire before age 62 than those without, and both men and women with defined contribution plans were less likely to do so.

Because with defined contribution plans benefit levels depend on total employer and employee contributions and investment earnings, they do not offer the same age-related retirement incentive as defined benefit plans, the GAO said. In addition, since at retirement most DC plans allow people to receive the accumulated value of the funds in their account as a lump sum, individuals also bear the risk of outliving their resources. The fact that different people will make different contribution and investment decisions is likely to lead to a greater variability in retirement ages, GAO concluded.

The report pointed out the necessity of the analysis was driven by the fact that the age at which workers retire is important for the sake of their retirement income security, the cost of federal programs for the elderly, federal tax revenue, and the strength of the U.S. economy. For the report GAO assessed:

  • The incentives federal policies provide for when to retire,
  • Recent retirement patterns and whether there is evidence that changes in Social Security requirements have resulted in later retirements, and
  • Whether tax-favored private retiree health insurance and pension benefits influence when people retire.

“Ultimately, it will be important for policy makers to understand the incentive structures that their policies create, and to coordinate their decisions to allow for individual flexibility, but send signals that consistently encourage those who are able to continue working to do so,” GAO concluded in its report.

The GAO report is available at http://www.gao.gov/new.items/d07753.pdf.

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