By Mark Olsen, Managing Director at PlanPILOT
Retirement for the American worker is a popular topic today, not only in the financial media, but also in the halls of Congress, where new legislation is continually considered to offer more retirement options, especially in employer-sponsored plans. The Pension Protection Act of 2006 and the SECURE 2.0 Act of 2022 are examples of bills that made significant changes and allowed for new features to be offered in retirement plans.
Bull’s-Eye on the Retirement Year
One of these changes is the increased inclusion of so-called “target-date funds” (TDFs). These investments have become a popular fund selection in employer plans since their introduction after 2006. As an example, Vanguard Funds reported that TDFs grew in their plans as the default choice for new-entry participants from 71% in 2013 to 90% in 2022.
As about 20% of retired workers leave their accounts within their former employer’s plan, there has been a growing need to address the investment preferences and objectives of retired workers who do leave their money with the employer plan. Given the growth of deferrals flowing into TDFs and many participants continuing to leave their money in the 403(b) plan, some non-profit employers are selecting customized target-date solutions to accommodate the needs and objectives of these former employees.
Understanding Target-Date Funds
Target-date funds are specialized asset-allocation investments designed to relieve the investor of having to decide the asset allocation percentages between equities (stocks), fixed income (bonds), and cash/money market funds. As the investor approaches their intended retirement age, these allocations become automatically more conservative on the premise the investor becomes less risk tolerant.
Depending upon the desired “target year” selected, the fund is structured and managed to “rebalance” the asset allocation based on the shrinking time horizon, so by the intended retirement age, the fund’s holdings generally reflect a less volatile (less risky), balanced allocation between equities and fixed income/cash. Yet even for the retired employee-participant, this allocation may be appropriate for some, but not others. Some retirees may wish further enhancements or selections to bolster diversification and lower risk.
Enhancing Investment Holdings for Retired Employees
Customization also includes examining the holdings and makeup of the target-date funds themselves. Even though the target-date year (at or near the retirement year of the participant) between two different fund families may be the same, the actual composition of the funds may be significantly different. To address the needs of post-retirement participants, employer plan sponsors are requesting customization of target funds that include non-core investments that may be only available in the particular fund. These include natural resource and other “real” assets, non-core fixed-income assets and other alternatives that may not be prudent to offer all plan participants.
Instead of customization of target-date funds, some plan sponsors have also begun to request more fixed-income investment choices for the plan menu, since most post-retirement participants naturally gravitate toward a greater allocation of less-volatile fixed income holdings as they age and are no longer working. In addition, as the percentage of post-retirement participants in a given 403(b) retirement plan increases, sponsors have recognized the benefits of providing a greater array of fixed income to both current employees and retired former employees.
Providing Secure Protected Lifetime Retirement Income
A significant feature also available today is the ability of the participant to annuitize a portion of their retirement account to create a dependable stream of lifetime income. The SECURE 2.0 Act allowed and encouraged employers to incorporate in-plan annuities as a feature of retirement plans.
Studies cited by Fidelity Investments (by the Employee Benefits Research Institute 2021 survey) indicate that 78% of workers would be interested in such a feature to ensure they don’t outlive their savings. Studies by notable retirement research specialists, such as Professor Wade Pfau, have demonstrated benefits of including a “protected lifetime income” can lower longevity risk and other risks of retirement finances. In a research paper on the benefits of annuities, Dr. Olivia S. Mitchell, Executive Director of the Pension Research Council at the Wharton School of Business, states that “most people would be better off if they had access to deferred income annuities in their …accounts….”
Implementing These Enhancements May Be Complex
Customization is an enticing concept, but usually also requires advanced expertise as to the pros and cons of implementing these features into an employer-sponsored retirement plan. With the increased focus on the plan sponsor’s fiduciary responsibility to participants, employers who lack such expertise are encouraged to utilize the knowledge and experience of retirement plan specialists to help design and implement these enhancements.
At PlanPILOT, our company is uniquely positioned to help you with these objectives. If you’re ready to upgrade to a new standard for your benefit planning, reach out to us at (312) 973-4913 or send an email to mark.olsen@PlanPILOT.com to learn more about how we can customize our services and your plan to fit your unique needs.
About Mark
Mark Olsen is the managing director at PlanPILOT, an independent retirement plan consulting firm headquartered in Chicago. PlanPILOT delivers comprehensive retirement plan advisory services to 401(k), 403(b), and 457 plan sponsors. His specialties include plan governance, investment searches, investment monitoring, and plan oversight. Mark is recognized as a leader in the industry and speaks at national conferences, including those organized by Pensions & Investments, and CUPA-HR.