While employers may want to provide better options to their employees, the fiduciary, financial, and administrative hurdles are steep. Retirees will have to pick from a small list of solutions until new alternatives are developed. This article by Milliman’s Kari Jakobe summarizes some of the existing approaches commonly used by retirees to convert their retirement distributions into a lifetime of retirement income.
Reducing an investor’s exposure to growth assets as retirement is approached is common. However, this strategy may increase the chance that an investor will outlive retirement savings. This is a predicament that many Australians face. In his article “Australia’s retirement challenge,” Milliman consultant Wade Matterson offers some perspective on how strategies employing derivatives can help Australians manage longevity and investment risks.
Pension plans are providing an ever-decreasing portion of retirement wealth as wave after wave of Baby Boomers reach retirement. In and of itself, this is neither surprising nor remarkable. What is remarkable, though, are two typical characteristics of what we are being left with regarding retirement wealth.
First, the jettison of pension plans means relying on defined contribution plans as the provider of principal retirement wealth. This is suboptimal inasmuch as these plans are typically 401(k) savings plans, originally introduced as a sideline fringe benefit scaled for purposes less than what they’re now required to deliver on. This is mostly a benefit-level issue of which we have seen recent hints of amelioration—namely, the industry recognizing that in an all-account-based retirement world, saving 16% of annual pay is in the ballpark, not the historical mode of 6% employee deferral (plus maybe 6% employer match totaling 12%). This relates to the second endangered characteristic, which needs to be brought into brighter focus: an in-plan solution for generating guaranteed retirement income.
Pension plans are wonderful for participants in that everyone is automatically a participant, automatically earning benefits on a meaningful trajectory, and automatically having the ultimate retirement wealth delivered on a lifetime guaranteed basis. Yes, 401(k) plans are trending this way on the first two, and the third is quickly emerging as another area where we need more pension-like alternatives.
One may generalize by saying that retirees take their 401(k) balances and roll them over when they retire. An economic conundrum baffling academics is that none or very few of these folks take advantage of insured annuities even in the midst of robust studies identifying them as an optimal solution for retirement income in face of investment uncertainty and longevity risks. This raises two subtle yet important points.
Milliman’s Kamilla Svajgl recently participated in a Pensions & Investments’ roundtable discussion focusing on the current climate of investment risks and behavior.
Here’s an excerpt:
P&I: What kind of strategies would work to help pre-retirees manage risk in this new world of higher volatility and lower returns — and help to keep them invested?
Kamilla Svajgl: Let’s start with the way people define asset allocation and risk. It used to be that “risk” was defined by an investor’s level of equity allocation. For example, 60% equity/40% bond portfolio was used as a proxy for “moderate risk.” There is a fundamental problem with that — a 60/40 portfolio would have experienced mere 7% volatility in the fourth quarter of 2006, but 67% volatility in the fourth quarter of 2008. I don’t think anyone is a moderate risk investor when they’re experiencing 67% realized volatility. These kinds of large swings in portfolio risk are not only highly correlated with sharp declines in the market, but also expose investors to significant behavioral risk of selling when asset values are deeply depressed.
A better way to define risk is by portfolio volatility. For a moderate investor, that might mean an overall portfolio volatility of 12%, for example. So the first step is to stabilize volatility. And the good news is that volatility lends itself very well to short-term predictive modeling. Therefore, while I will not be able to tell you if the market will go up or down tomorrow, I can be very accurate in assessing whether it will be calm or volatile.
The second step of the strategy is to add some additional downside protection for extra cushion. We achieve it by synthetically replicating a long-dated put option within the portfolio. This further reduces losses during periods of significant and sustained market decline. This approach has been used by large life insurance companies during 2008 to successfully hedge their balance sheets.
Combining volatility management and capital protection allows investors to stay invested in equity during calm market conditions, and at the same time protects them during times of crisis.
For a transcript of the entire roundtable discussion, click here.
Recently, members of Congress reintroduced the idea of opening the government-employees-only Thrift Savings Plan (TSP) to all Americans not currently covered by an employer-sponsored plan. Right now, that number is estimated at 78 million U.S. workers. According to the Bureau of Labor Statistics, as of early 2013, 68% of all workers had access to a defined benefit (DB) or defined contribution (DC) plan and 54% were enrolled. The vast majority of workers not covered are part-time or seasonal employees. The government recognizes that help is needed, and the TSP proposal is the latest attempt.
In place since 1986, the Thrift Savings Plan (TSP) has provided federal employees and military service members with retirement savings. It is a defined contribution plan, similar to 401(k) plans offered by corporations. A governing board, consisting of six people who are presidentially appointed, administers the plan. A variety of issues should be considered with this proposal, but there are a few important advantages and disadvantages.
• The most important aspect of this proposal is that it would provide payroll-based savings to millions of American workers—people who do not now have access to employer-sponsored retirement savings accounts.
• The Thrift Savings Plan is a simple plan with an auto-enrollment feature, six investment choices, and low fees.
• Because it is run by government agencies, taxpayers are technically funding the costs of the plan, so opening it to all Americans is a fair proposal.
• Increasing the TSP population this significantly would have a profound impact on the retirement savings industry that is hard to predict. Both private and government providers may benefit from increased competition.
• Administration of the TSP would require a major upgrade at a minimum, and possibly an entirely new system.
• With TSP membership this massive, government agencies would have a greatly increased, more powerful role in the retirement savings industry, and selection of investment fund options might take on a political element (at least the perception of such). This is the biggest concern that has been voiced.
• Potential compliance issues would be introduced as the TSP is exempt from ERISA and Internal Revenue Service regulations that govern the private sector. Independent review/oversight of the TSP would have to be in place. The TSP is required to adhere to regulations under the Federal Employees’ Retirement System Act (FERSA). These regulations are more lax.
• The conservative investment options offered by the TSP deliver the security and returns associated with long-term Treasuries, which are not protected against inflation.
All employees deserve the availability of a retirement savings plan. The difficulty lies in determining the best option to accomplish that goal. Inviting American workers not covered by an employer-sponsored plan to the TSP may not represent the best solution. The administration-sponsored “myRA” is already taking a step in that direction. This starter retirement account offered by the Department of the Treasury gives workers access to the most conservative of the six TSP funds, the G fund. MyRA will serve as an important first attempt, on a manageable scale, and will provide important input to the comprehensive solution. The time may be right for Congress to undertake a complete review of this area. Hopefully, employers will be included in these discussions.
All around us, there are signs that spring is hatching. Snow piles are melting, potholes are mounting, insulated jackets have been shed, green grass is peeking through, and bird nests are popping up in the trees.
It’s important to remember that, just as a mother bird continues to nurture her unhatched eggs, your retirement accounts need a little nurturing until they’ve reached their maturity. Perhaps it’s time for a little retirement account spring cleaning!
According to this New York Times article, statistics show that, on average, people in their 20s will go through seven jobs in their lifetimes. It’s not uncommon to get wrapped up in the new and forget about the old—more specifically, your retirement account—as you move forward to new opportunities.
If you’re not sure how to access old accounts anymore, your prior employer will be able to point you in the right direction. It would be unfortunate to leave a nest egg behind only to have it eaten up by plan fees!
Here are a few things to keep in mind:
- It’s helpful to update your contact information if you move, get a new phone number, or change your name. Some of these changes may require that you provide proof of change and it’s easier to stay on top of the changes as you go.
- Remember to review and update your beneficiaries as you go through life changes to make sure your retirement accounts are inherited by the appropriate parties if an unfortunate incident occurs.
- Every few years, you may want to re-evaluate your personal investment selection. The fund or portfolio you picked when you started that first job at age 22 may no longer fit your investment strategy.
- How much do your retirement accounts cost you? Even in employer-sponsored retirement plans, participants often are responsible for paying portions of plan fees. If you have five separate accounts and each of the plans deduct $25 from your accounts each year ($125 in total) it might be wise to consolidate your accounts and only pay one $25 fee.
- If you have a small balance, typically under $5,000, you may be automatically rolled out of the plan and into an IRA, without your consent. If your account balance is less than $1,000, your account may be automatically paid directly to you, less taxes owed. Make the first move after leaving so that finding your account doesn’t make you feel like you’re chasing your tail.
- If nothing else, check in on your accounts at least annually. Even if you are no longer working at the company, plan design changes, fund changes, and many other decisions the company makes for its plan still affect your account and could affect your account balance.
- While it’s still fresh on your mind, consider combining all of your prior qualified accounts into your current plan or IRA. One of the major benefits of qualified 401(k) plans is that they are portable and most retirement plans make rolling balances in or out a fairly easy process.
Just think. You work hard for your money and if you contributed to a retirement plan, that money was withheld from your take-away pay. Consolidation increases the likelihood you’ll be able to devote the attention you need to grow your retirement nest egg.