Putting the Future in Focus
What to Do About Tomorrow Today
By Tony Mastrogiorgio
The science fiction writer William Gibson has said, "The future is already here — it's just not evenly distributed." Nowhere is that more true than it is in the world of retirement.
We have understood for decades that demographics, particularly the aging population and shrinking workforce, were driving changes that would render the existing benefits structure unsustainable. Well, guess what? Baby boomers are already retiring — up to an estimated 35 million over the next ten years. The future, or at least one version of the future, is already here.
But so is the positive (possible) future. Many of the solutions, trends and best practices that may help us manage the challenges we face are already here. There is more to be done, more evolution that has to take place, and more trial and error ahead, but the future, however unevenly distributed, is here.
Surveying the Uneven Landscape
Let's consider a specific example of the uneven presence of the future: the use of target date funds. Today, target date funds capture nearly 65% of inflows1 into DC plans. With QDIA and safe harbor protections in place since the Pension Protection Act (PPA) of 2006, it is highly likely that anyone who has joined an employer sponsored plan over the last few years is in a target date fund.
During this time of rapid growth for target date funds, the selection of funds expanded and customization options have generated increased interest. Their continued evolution may eventually recreate much of the retirement experience enjoyed by participants in traditional defined benefit plans, particularly if income solutions can be incorporated into their decummulation phase.
Unfortunately, research2 shows that the longer participants have been in a DC plan, the less likely they are to be in a target date fund. If you have been a loyal employee for fifteen years, you are likely to be in an outdated investment plan. If you join the firm today, you will probably be automatically placed in a target date fund at a reasonable deferral rate and enjoy the benefit of the most up-to-date best practices.
The bottom line is that in many plans, the future and the past sit side by side. The challenge is to find the future and get it in focus.
What to Do About Tomorrow, Today
The gap in the application of best practices across a single participant population could emerge as a fiduciary issue in the years to come, which may encourage some plan sponsors to consider reenrollment as a means of reducing that risk.
And while reenrollment is often an excellent, albeit underutilized, tool that we believe is worth consideration, jumping to a given tactic without first stepping back to get the future into focus is a mistake. Without a proper framework, corrective action can lead to unintended consequences or uneven results.
That's where the concept of putting the future in focus comes in. But that is not as simple as it sounds: set your gaze too firmly on the future and you may trip over something right at your feet. Can you set your focus on something suitably aspirational, yet practical enough to provide immediate touch points to help you decide what to do today?
We believe that you can. Three simple steps can help you gain clarity and make the choices to create better outcomes for your participants. Let's start with:
1. The Fine Art of Thinking Backwards
When building a target date fund, the first question to ask is "what is the objective?" Whether the objective has to do with preserving spending power in retirement or maximizing every dollar invested (or something in between), every decision from the glidepath to the asset allocation and implementation flows from where we want participants to finish. In other words, the end helps clarify the means.
It is the same with the overall DC plan. Too often, a DC plan is considered the end in itself: we have one because we're expected to have one. Others have clearly articulated a goal for their plan, but did so years ago, in a very different retirement landscape, and haven't revisited it since.
Consider some of the DC plan objectives we have heard from plan sponsors: "Allow my participants to retire at an appropriate age"…"Provide a competitive DC plan"..."Provide retirement income"..."Fulfill our fiduciary responsibilities."
Each objective has nuances that will recommend specific avenues to explore. Driving retirement readiness by an appropriate age may require focusing on current participation and deferral rates. Providing retirement income may require specific investment products or services. Focusing on fiduciary responsibilities adds another lens through which to examine choices.
2. Recognize the Limits of Influence
Which would you rather participants do: worry constantly about the market, or get into good savings habits that will help them steadily build their nest egg? The answer is obvious because there is nothing they can do about the markets, but they can control their behavior.
The same principle applies to plan sponsors; they need to recognize not only what they can and cannot influence, they need to understand the range and limits of the influence they can exert. For example, the plan cannot control the market, but through the investment menu, it can limit or increase the impact the market has on their participants return.
What's more, they need to think about the hierarchy of influence. Where does it make the most sense for them to concentrate their efforts? What are the broad moves that are within their power to create better outcomes? And what moves are more narrowly focused? Contribution rates and participation rates can be heavily influenced by plan sponsors and can have a massive impact across the entire participant population. Picking a manager for a specialized asset class, while important, has a much narrower impact.
If thinking about the plan objective brings the intended future in view, thinking about the hierarchy of influences brings the path to the future into better focus.
3. Work the Controls
With the goal in focus and a solid understanding of where we can exert influence, we can work our way back to the specific tactics. We have a context that lets us act now without getting off course.
Most of the controls are widely known. It isn't a question of knowing what to do; it's a question of knowing what to do next and what will do the most to further your objective. Consider the plan objective, "Ensure adequate savings."
While market exposures and investment choices can certainly have an impact on savings adequacy, they are not the primary influencers. Frankly, the most significant influencer is participant behavior. If they understand the importance of their DC plan to their retirement future, and they put that understanding into practice through diligent savings habits by participating in their plan and maximizing their contributions, they are very likely to accumulate an adequate savings.
Unfortunately, we know that for a variety of reasons, participants won't do this. However, we also understand how to nudge them in the right direction. The controls we can adjust include auto-enrollment and auto-escalation, so that all new employees begin saving at an adequate level and gradually increase their contributions; adjusting the company match to encourage greater deferrals, for example by changing a straightforward 4% match to matching 50% of the first 8% deferred; and a full reenrollment into a QDIA at a higher initial deferral.
These controls are all within the power of the plan sponsor to use, and they are known to be effective. They are however — to return to our theme — unevenly distributed. Changes in an inefficient, unfocused plan may improve outcomes, or they may increase the inefficiency or, worse, have no effect and foster a belief that there's "nothing anyone can do."
But by bringing the future in focus, understanding our objectives and working backward from the ends to the logical means, we can begin to take care of tomorrow, today.
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