DC Plan Sponsors Should Focus More on Deferral Rates

Other factors are more important to defined contribution (DC) plan success than fund performance, according to research from Putnam Institute.

A Putnam Institute research paper, Defined contribution plans: Missing the forest for the trees?, shows that a number of variables are at work in determining plan effectiveness, including deferral rates and plan design, asset allocation, rebalancing behavior, and individual fund performance. Putnam contends that the industry would do well to bear in mind this hierarchy when considering ways to boost retirement preparedness.   

“As we look at the progress participants are making toward securing a better retirement savings outcome, deferral rates are one of the most important factors to stress, whether in communication to participants about how to accumulate more wealth or in restructuring DC plans for better saving and investing success,” W. Van Harlow, Ph.D., CFA, director of research at the Putnam Institute, wrote in the paper.  

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

While it is not surprising that if a person saves and invests more, he might be more likely to accumulate greater wealth, but the study found the size of the difference in terminal wealth can be dramatic. As an individual’s contribution increases from 3% of income to 4%, 6%, and 8%, the final balance after 29 years jumps from $136,000 to $181,000, $272,000, and $334,000, respectively.

 

(Cont...)

Even a 4% deferral—which represents a 1% increase that does not take advantage of the plan’s full matching contribution—would have a wealth accumulation impact 30% larger than the “crystal ball” fund selection strategy, nearly 100% larger than the growth allocation strategy, and approximately 2,000% larger than rebalancing. “Putting deferral rate changes in these terms, the performance of underlying funds and rebalancing, in particular, appear to become far less meaningful when compared with the impact of higher deferral rates,” Harlow noted.  

The study data suggest that focusing on helping eligible employees enroll and/or increase their deferrals into their DC plan is an effective way to help boost wealth accumulation potential. Therefore, Putnam says services such as auto-enrollment and auto-deferral increases are two critical best practices that plan sponsors should consider implementing.   

According to the paper, a qualified automatic contribution arrangement (QACA) that increases an individual participant’s deferral rates from 3% to 10% by one percentage point annually—and then maintains a 10% deferral rate thereafter—would have roughly the same impact as an 8% deferral rate over the 29-year time frame employed in the study. “Clearly, auto-escalation features can play a vital role in helping secure substantially higher savings for plan participants, particularly the majority of savers who have historically tended to participate passively in their plans,” Harlow said.  

The research paper is available here.

 

Addressing Social Security an Important Task for Advisers

Financial advisers consider addressing the issue of Social Security with their clients to be a central and important task, a recent analysis finds.

Nearly nine in ten (88%) advisers surveyed for a Pension Research Council working paper believed that it was incumbent upon them to educate their clients about how Social Security fit into their retirement finances. Independent financial advisers (93%) were particularly aware of the responsibility to address Social Security with their clients, especially compared to bank representatives (80%).   

Further, most advisers specifically believed they should help their clients decide when to claim Social Security benefits. Wirehouse and regional broker dealers (68% each) were most likely to suggest advising clients about claiming, while life insurance agents (62%) were least likely to feel they should do this.   

Want the latest retirement plan adviser news and insights? Sign up for PLANADVISER newsletters.

The advisers surveyed strongly believed that helping their clients make decisions about their Social Security benefits was an important part of their role. Moreover, for most clients, Social Security benefits made up a significant portion of their incomes in retirement. Three-quarters of advisers (76%) discussed  Social Security with most of their clients, including the 41% who raised this subject with virtually all of their clients (90% to 100%).  

In around half the cases, the advisers tended to bring up Social Security, but many times it was the client who brought up the topic. Advisers generally raised the issue of Social Security to clients around a median age of 55. When clients raised the issue, the discussion started later, at a median age of 60.  

More than three out of five advisers (62%) talked to most of their clients about strategies for maximizing Social Security benefits. That same proportion (62%) said they also addressed the subject of taxation of benefits. Fifty-seven percent explained the Retirement Earnings Test to most clients.   

Fifty-six percent of advisers helped at least three-fifths of their clients estimate their Social Security benefits, but fewer, 46%, advised that proportion of clients about how spousal benefits worked.   

Three of four financial advisers (75%) asserted that they advised clients about claiming Social Security benefits. Independent financial advisers and regional broker dealers were most likely to provide this advice (82% each), while bank representatives (67%) and life insurance agents (63%) were least likely.   

More specifically, two-thirds (66%) advised clients about the best age to claim Social Security benefits. The paper discusses in detail advisers’ beliefs about the best age to claim Social Security benefits and what factors contribute to their conclusions.

Financial advisers felt they were knowledgeable about Social Security and understood several key details about its benefits. Nearly all advisers (93%) said they were knowledgeable about how Social Security works, with 22% describing themselves as very knowledgeable, and an additional 71% saying they were somewhat knowledgeable. Six percent asserted they were not knowledgeable about Social Security.  

Financial advisers are often critical of the material on Social Security provided to them and their clients: only 26% feel that the material their primary company provides for their clients is useful. Moreover, only 13% agree with the statement that ‘[t]he Social Security Administration does a good job educating financial professionals about how Social Security works’. Fifty-one percent disagree with the statement.   

Although two in three advisers (65%) have visited the basic Social Security website, there is low awareness that Social Security has a website especially for financial planners. Two in five who visited the website rated it excellent or good, but 13% felt it was fair or poor.  

The Pension Research Council working paper can be downloaded from here. A free registration is required.

«