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Americans Value
Their DC Plans
Most believe 401(k)s will prepare them adequately
for retirement

Three-quarters of American households expressed confidence in the ability of 401(k) and other defined contribution (DC) plan accounts to help people meet their retirement goals, a new Investment Company Institute (ICI) survey finds.

In the eighth annual update of “Americans’ Views on Defined Contribution Plan Saving,” ICI reports that 66% of survey respondents, young and old, with defined contribution plan accounts agreed that saving from every paycheck made them less worried about stock market performance. Ninety percent of DC-plan-owning households agreed these plans helped them think about the long term and made it easier to save.

The study suggests that defined contribution plan design encourages workers to save and invest for retirement on a regular basis, says Sarah Holden, ICI’s senior director for retirement and investor research, in Washington, D.C. “Most DC-plan-owning households indicated payroll deduction made it easier to save,” she says. “They also valued choice in, and control of, their DC plan investments.”

Eighty-eight percent of households disagreed with the idea that the government should remove the tax advantages of defined contribution accounts, and 90% disagreed with reducing the amount individuals can contribute to them. These percentages are unchanged from a year ago.

Even among households with neither these nor individual retirement accounts (IRAs), 80% rejected the idea of taking away or reducing the accounts’ favorable tax treatment. About eight in 10 households with such accounts cited the tax treatment of their retirement plans as a big incentive to contribute.

Among households expressing an opinion in the survey, 90% had positive impressions of 401(k) and other defined contribution plans. Nearly all DC-account-owning households valued design features such as choice and control over investments.

U.S. households, whether they owned retirement accounts or not, continued to express confidence in DC plans’ ability to help individuals meet their retirement goals. Eight in 10 households owning these accounts or IRAs indicated such confidence. Even among households with neither, three in five reported having this confidence.

—PA

Investors Still Need Coaching
Advisers can’t just let participants ‘set it and forget it’

J.P. Morgan Asset Management has updated its “Ready! Fire! Aim?” research series for 2016, examining how the relationship between target-date fund (TDF) glide paths and participant behaviors shapes long-term defined contribution (DC) portfolio outcomes.

Dan Oldroyd, portfolio manager and head of J.P. Morgan’s target-date strategies, in New York City, notes that participant behavior in the last few years was “much more varied and volatile than many target-date fund providers have assumed in their asset allocation models.” Examples of “varied and volatile” behaviors include over-active trading during periods of market stress or buying into a target-date fund with an inappropriate retirement date, Oldroyd says. Other participants have reduced their contributions, taken loans or been opted into plans for the first time at a grossly insufficient salary deferral level.

“The prevalence of such behaviors led us to consider [their] potentially significant ramifications for whether participants would be likely to meet their retirement funding needs,” Oldroyd says. He adds that he is personally excited about this third update to the research series, “which now provides more than 10 years of data examining how participant behavior, such as [that affecting] the size and timing of portfolio cash flows, interacts with the size and timing of market returns.”

Oldroyd says the data clearly shows salary levels and raises are crucial behavioral inputs for predicting TDF investor success, “because income levels influence contribution amounts, as well as the standard of living that needs to be replaced in retirement.” Predictably, target-date fund investors receiving regular raises and having higher salaries to begin with have greater success preparing for retirement via the investment markets than do more poorly paid investors. Unfortunately, Oldroyd points out, the latest data shows that “average raise frequency has declined to pre-crisis levels because … earlier increases were mainly caused by an apparent salary catch-up from the post-crisis slowdown.”

In other words, people get raises less frequently these days compared with during the last decade, requiring portfolio managers to reassess their glide path structures due to lower anticipated future contributions. Additionally, average raise size declined somewhat in the last 12 months as well, although still remained slightly above inflation, he says.

Tied to the slowing raises, J.P. Morgan finds that the average starting contribution rate to target-date funds and other retirement plan investments continued to fall, “with subsequent average increases rising much more slowly.” —John Manganaro

Alternatives Aversion: The 2015 PLANSPONSOR Defined Contribution (DC) Survey found that only 4.6% of all DC plans offer alternative funds—including private equity funds, hedge funds and other alternative approaches packaged as liquid securities—in their lineup. 

Higher Health Costs for Singles
Couples have the advantage of relying on each other

Singles and couples ages 65 and older tend to face sharply different expenses for nonrecurring health care services such as home health care, nursing home stays, overnight hospital stays and outpatient surgery, according to research by the Employee Benefit Research Institute (EBRI), in Washington, D.C.

In contrast, recurring health care expenses—e.g., doctor visits, dentist visits and prescription drugs—averaged about $2,500 per person for both singles and couples aged 65-plus between 2010 and 2012. The biggest expense was prescription drugs, costing single households an average of $1,766 and couple households an average of $1,609 per person.

“The most important observation from these two figures was that per-person out-of-pocket recurring health care expenses were [no] different between single and couple households,” EBRI says. The research organization also says recurring health care expenses generally do not increase as a person ages.

Nonrecurring health care expenses, however, cost single households an average of $7,122, but couple households only $3,161, over that two-year period. And those expenses increase with age; for households 85 and older, singles spent an average of $13,355 on nonrecurring health care expenses, and couples, $8,530. EBRI Research Associate Sudipto Banerjee theorizes the discrepancy might be due to a spouse acting as the other’s caregiver.

“Health care expenses are a major concern for retirees,” EBRI concludes. “But some retirees should be more concerned than others. Certainly, those who have existing medical conditions are likely to spend more. But, at a more general level, singles are likely to spend more on health care services than couples.” —Lee Barney

The Bare Essentials: Because people are saving more, and investing more appropriately for their age, the percentage likely to afford at least their essential expenses in retirement has risen to 45%, up from 38% when Fidelity Investments last conducted its biennial Retirement Savings Assessment study.

Calculating
Retirement Income
A widely accepted method omits several key factors

The income replacement rate (IRR)—i.e., income immediately following retirement divided by income immediately preceding retirement—is commonly used as a measure of economic preparation for that post-employment life stage. Various online calculators, for example, suggest that retirement IRRs should exceed 70% of pre-retirement income.

In “Measuring Economic Preparation for Retirement: Income Versus Consumption,” a white paper by RAND Corp. Senior Economists Michael Hurd and Susann Rohwedder, the authors contend that the widely accepted concept overlooks a number of relevant issues. They consider two variations of IRRs to better address some of the complexities of contemporary labor and investment markets to workers nearing retirement.

Their findings imply that the income replacement rate is of little use for assessing economic preparation for retirement. The chances that someone with a low income-replacement rate is well-prepared are not much different from the chances that someone with a high income-replacement rate is well-prepared, they contend.

The standard calculations may have made sense in an era when pre-retirement income almost exclusively comprised earnings and when post-retirement income comprised Social Security and defined benefit (DB) pensions. The formula’s simplicity and the transparency of the concept have contributed to its use.

For one thing, defined contribution (DC) plans have supplanted most defined benefit plans—and DC values depend not only on the plan participant’s contributions, but also on movements in the markets in which those plans are invested.

Some people, for instance, make nontraditional transitions from full employment to full retirement. Additionally, members of a married couple transition to retirement at different times. Many people have other forms of financial wealth that are not always thought of as sources of income but that could serve as such.

In its simplest form, the IRR has not been redefined to accommodate these other potential income sources. As a result, the tool understates the degree to which workers have adequately prepared economically for retirement relative to enhanced forms that do account for those income sources.

Post-retirement income options have also diversified to the extent that one household may have two earners with retirement ages that differ, either because they were born widely apart or because each prefers a different age to retire. Given the complexity added by a second earner, determining the timing of a couple’s retirement and quantifying pre- and post-retirement incomes is a difficult planning problem that cannot be solved by a simple ratio with a few values. —Jill Cornfield

Stable Value Conundrum
Few DC plans offer stable value on the investment menu

For years, less than half of defined contribution (DC) plans have offered stable value funds. Prudential Retirement set out to understand the barriers to adoption of the funds and discovered that growing numbers of plan sponsors and intermediaries may, in fact, be open to embracing stable value; the findings are in a new Prudential white paper “Expanding the Case for Stable Value.”

In some ways, those who are cool toward stable value may be considering the wrong factors. For example, those recommending it cite its returns compared with those of other fixed-income investments, as well as how it boosts participation and deferral rates. Non-adopters, on the other hand, cite stable value’s performance relative to equities and other non-fixed-income asset classes and believe it may be difficult for plan participants to understand, says Gary Ward, head of stable value at Prudential Retirement in Woodbridge, New Jersey.

For Prudential Retirement, the research prompted an evaluation of how the firm tells the story of stable value’s benefits to an individual investor. “I didn’t expect to hear as much as we did about benefits—that plan sponsors and intermediaries really see the connection of stable value to broader participant engagement,” Ward says. “They see it as a driver of higher participation and deferral rates.”

One key to educating plan sponsors and investment committees about stable value is a deeper articulation of the value equation of the asset class, according to Ward. “We need to emphasize all of the benefits of stable value, such as the history of bond-like returns with low volatility, capital preservation, liquidity to participants, and potential to drive higher participation and deferral rates,” he says. “And we need to continue analyzing real or perceived concerns around cost and complexity.”

Awareness alone is not the issue. Prudential’s data shows that almost all advisers (91%) and most plan sponsors (82%) are somewhat to very familiar with stable value, and plan sponsor and intermediary attitudes toward broader use of it are favorable. Among plan sponsors, 55% of non-adopters plan to offer the option in the future, while only 9% of adopters are at risk of getting rid of it. For advisers, 30% of those who recommend stable value to clients are doing so more often than they did a year ago, and 35% expect this trend to accelerate over the next three years.

New money market fund rules may also spur greater use of the strategy: Beginning in October, the Securities and Exchange Commission (SEC) will allow money market funds to impose redemption fees, or temporarily halt redemptions—which could fuel more interest in the funds as an alternative. Sixty-three percent of sponsors that offer money market funds and 49% of advisers who recommend them say the SEC ruling is likely to drive changes in their allocation to those funds.—Jill Cornfield

Social Security Income
The CBO paints a more positive picture than the SSA

The Social Security Administration (SSA) calculates pre-retirement income replacement rates using career-average earnings, but indexed for the growth of wages economywide. It says replacement rates average only around 40%.

However, the Congressional Budget Office (CBO) has performed a new analysis of pre-retirement income replacement rates, which is limited to workers’ last five years of substantial earnings before age 62, adjusted for growth in prices.

Overall, a person born in the 1960s who is in the middle quintile of lifetime earnings can expect Social Security to replace 56% of pre-retirement income, the analysis finds. These new percentages, compared with the Social Security Administration’s average income replacement, could help individuals better plan for retirement.

The analysis shows replacement rates are much higher for workers with lower earnings—95% for a person born in the 1960s who is in the lowest quintile of lifetime earnings. This advantage owes partly to the progressive nature of Social Security’s benefit formula and partly to the tendency of those workers’ late-career earnings to be lower than their lifetime earnings, which determine benefits. Also, though replacement rates are similar for men and women, they are higher, on average, for men in the lowest household earnings quintile—those males earn less, late career, than do women in that group, relative to either gender’s lifetime earnings. By contrast, replacement rates are noticeably higher for women than for men in the highest quintile because those women earn less, late career, than do men.

However, the CBO notes that, with the reported expected insolvency of the Social Security trust funds, the benefits actually paid to certain groups would replace less income than what is scheduled to be paid. For example, a person born in the 1960s who is in the middle quintile of lifetime earnings is scheduled to receive benefits that would replace 56% of pre-retirement income, but if the trust funds’ financials continue to erode, what is actually paid to the person would replace only 49% of that income. The CBO report notes that for people in the cohorts that first receive benefits after the trust funds run out, replacement rates would drop noticeably.

—Rebecca Moore

Get Smart on Firm Value
Fidelity finds advisers don’t take
the time to properly evaluate their practice

Each time it is updated, the “Fidelity RIA [Registered Investment Adviser] Benchmarking Study” serves as a lasting source of insight into practice management trends and the challenges that should be top of mind for advisory firm owners, says David Canter, executive vice president for practice management and consulting, Fidelity Clearing & Custody Solutions in Boston.

A fresh cut of the 2015 edition shows there are some real emerging threats to firm value. These include a shortage of human capital, as well as a “serious lack of understanding regarding what drives firm valuations,” Canter says.

According to the new data, just 38% of firms have a strong grasp of what can drive firm valuations when a practice is actually put on the selling block. “In addition, the study identified several challenges to optimizing firm value,” Canter says, “the top one being that many firms simply don’t make it a priority.” This can potentially result in a lower than anticipated price for the firm when it comes time to sell, merge or transition the business to internal successors, according to study results.

“A firm’s value is dependent on many factors—some of them, such as size and revenue, are widely known,” Canter says. “Other valuation drivers, such as client demographics, may not be so obvious, but firms still need to consider them in order to get a clear picture of their worth. The demographics of their clients—which can shed light on whether those accounts may grow or depreciate over time—can indicate a lot about a firm’s current stability and its ability to grow revenue in the future.”

It is not surprising that a greater percentage of high-performing firms have an “advanced understanding of what can drive business value” than do average or weakly performing firms (48% vs. 40%), and more high-performing firms have established an “agreed-upon mechanism for determining firm value in the event of an internal transition” than have the others (75% vs. 61%).

Perhaps as a result of their deeper business intelligence, high-performing firms are more confident in their people, Fidelity says. In fact, a strong majority (63%) of high-performing firms agree with the statement: “Our people have all the skills and training for us to achieve our strategic goals.” This compares with less than half (49%) of all other firms. —John Manganaro

In the Dark on Retirement Income: Fifty-six percent of Americans have no retirement income strategy, and, among those who do, the most sophisticated plan is simply withdrawing money from savings accounts—a tactic LIMRA does not recommend.