Data & Research June 6, 2013

PSNC 2013: 401(k)s Under Attack: I Don’t Get It!

The 401(k) industry continues to undergo scrutiny and criticisms—many of which are unfounded.
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According to Joe Ready, EVP and director at Wells Fargo Institutional Retirement and Trust, plan sponsors and providers are spending billions of dollars educating America about how to prepare for retirement, and plan sponsors contribute 35% to 36% to participants’ balances, so why is the industry under attack? He told attendees of the PLANSPONSOR National Conference that the industry is sometimes its own worst enemy, reporting about the wrong averages.  

For example, 401(k)s are not only a benefit for the highly paid—80% of participants earn less than $100,000 and 40% earn less than $50,000. “We need to emphasize in conversations that 401(k)s benefit the middle class,” Ready said.  

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According to Ready, a look at the Wells Fargo book of business shows the average 401(k) distribution is $125,000, which could generate $650 per month in income for life in addition to a $1,165 monthly Social Security payment. He noted that when we consider that for participants turning 65 now, the 401(k) was introduced as a supplement to retirement savings, so the Wells Fargo data shows it has served its purpose for those participants. Now the game has changed, and 401(k)s are a primary savings vehicle, he added.

Ready also pointed out that we hear the average deferral rate for participants who were automatically enrolled is 4.3%, but industry data shows the average deferral rate for participants who are not automatically enrolled is 6.9%. Ready said this shows that employees for whom plan sponsors are not making decisions  have gotten the message that they need to save, and at higher rates.

We also hear the average 401(k) balance is $76,000, but industry data shows that for participants in their 50s and 60s, the average balance is in excess of $200,000. And regarding the statistic that only 50% of workers have access to a retirement plan—Ready said this includes seasonal and part-time employees. When only full-time workers are considered, 80% have access to plans.  

Of course, there are still things the industry needs to work on, Ready noted—increased diversification of participant investments, decreased number of loans and withdrawals and an increased auto-enrollment deferral percent. But, he concluded, “Although there is still work to be done, we are making a difference in the quality of life people will have in retirement.”

The Markets June 6, 2013

Maybe DC Plans Should Be More Like DB Plans

Reducing volatility and expanding investment options for defined contribution (DC) plans could improve risk-adjusted returns, according to BNY Mellon.
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In a white paper, investment management firm BNY Mellon examined the broadening of investment options available to DC retirement plans to include real assets, emerging market equities and debt, and liquid alternatives and how that could improve risk-adjusted returns while reducing volatility and providing better protection against inflation.

“Traditional DC plans do not provide the level of diversification and risk balance that plan participants require to achieve their retirement goals,” said Robert G. Capone, executive vice president, BNY Mellon Retirement Group, and author of the paper, “Retirement Reset: Using Non-Traditional Investment Solutions in DC Plans.”

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Capone attributed the limited range of investment options in DC plans as the primary reason for their inability to match the performance of defined benefit (DB) plans, which tend to incorporate a range of non-traditional assets. Capone noted that non-traditional approaches could enhance the success of investors in the current environment, which he expects to be characterized by higher volatility, heightened inflation risk and returns that are expected to be lower in the long term.

If DC plans were constructed more similarly to DB plans, approximately 20% of plan assets would be allocated to non-traditional strategies, such as real assets, total emerging markets (which combine equities and fixed income) and liquid alternatives, BNY Mellon said.

“Equities comprise a higher percentage of the DC portfolios than they do of DB portfolios,” Capone said. “We believe that applying the best DB practices to DC plans would reduce equity risk and home country bias as well as thoughtfully incorporating alternative investments to increase diversification, return potential and downside risk management.”

The real asset portion of the DC portfolio proposed by BNY Mellon is designed to hedge against inflation and would include Treasury Inflation-Protected Securities (TIPS), real estate investment trusts (REITS), commodities and natural resource equities.

The combination of emerging markets equity and fixed income would provide a more blended and balanced approach than allocating only to emerging markets equities, according to Capone. The more balanced approach has the potential to reduce portfolio volatility and diversify country and currency risks than could be accomplished with emerging markets equities alone.

BNY Mellon sees liquid alternatives as a way to provide DC participants with strategies that have a low correlation to equities markets. “There is a wide range of liquid alternative strategies,” said Capone. “So, we are using three hedge fund indices as proxies for this asset class.”

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