Plan Sponsors and Participants Need HELP

The Senate Committee on Health, Education, Labor & Pensions (HELP Committee) held a hearing titled “Pension Savings: Are Workers Saving Enough for Retirement?” on Jan. 31, 2013. Witnesses shared successful initiatives and highlighted areas that need improvement to help workers achieve a financially secure retirement.

Three-legged stool wobbly

TIAA-CREF’s Ed Moslander noted that the traditional “three-legged stool” — the standard visual analogy for retirement savings that includes defined benefit (DB) pension plans, Social Security and personal savings from defined contribution (DC) 401(k)-type accounts — has become increasingly unsteady. “Retirement has become much more of a ‘do-it-yourself’ proposition, where a large part of an individual’s retirement security depends on defined contribution plans,” he observed.

Mr. Moslander stressed the importance of employers’ recognizing that they share the responsibility for helping employees attain retirement savings goals. Accordingly, employers should offer matching contributions that encourage employees to contribute — for example, a dollar-for-dollar match when an employee saves up to a certain percentage of salary.

The “pervasive lack of financial literacy” in the US often means that employees aren’t equipped to make complex decisions about how much to save and how to invest those savings. To that end, TIAA-CREF believes it’s important to offer tools to assist clients with making these decisions, including online programs, access to advisors and comprehensive third-party advice programs.

Mr. Moslander also noted the inadequate focus on the draw-down phase of retirement, when people spend their retirement savings. Savers should receive information not just about their accumulated savings, but also about how their savings translates into income at retirement, as proposed in the Lifetime Income Disclosure Act introduced in the last Congress. He suggested that retirement plan providers include this feature now rather than wait for policymakers to require it.

Trilogy for success: participants, sponsors, service providers

Julia McCarthy of Fidelity Investments stressed three points:

    • Plan participants must take an active role in saving and managing their financial future.
    • Plan sponsors need rules and regulations with more flexibility to design plans that meet the diverse needs of their workforce without more risk of fiduciary liability and increased coverage cost.
    • Service providers need to continue to innovate to help plan sponsors optimize their benefit programs and serve participants based on their needs.

In addition, she outlined a number of key areas policymakers should consider to improve retirement savings outcomes, including programs to:

  • Increase the default deferral rate for automatic enrollment plans from 3% to 6%.
  • Incent more plans to adopt auto features, such as automatic annual increase programs.
  • Protect and promote the availability of education and guidance by service providers and recordkeepers.
  • Modernize and simplify the current regulatory framework to allow innovation in plan design and participant communications.
  • Explore new ways to encourage younger workers to build solid savings habits by enrolling earlier in their working careers.
  • Partner with school administrators, businesses and nonprofit organizations to help ensure all students have access to quality financial literacy.

Focus on women

M. Cindy Hounsell, president of Women’s Institute for a Secure Retirement, observed that retirement savings issues confronting all American workers — for example, not saving enough and not recognizing the need for a comprehensive strategy — are compounded for women. In addition, women grapple with other issues, including:

  • Generally longer life spans than men, which means they need more income and their retirement assets have to last longer.
  • Lower incomes than their male counterparts.
  • Interrupted work histories due to caregiving responsibilities.
  • A greater likelihood of working part-time jobs that don't offer retirement benefits.

According to Ms. Hounsell, women need to better understand retirement planning concepts, including:

  • Asset-to-income ratio.
  • The amount needed for a secure retirement.
  • Longevity risk.
  • The value of guaranteed lifetime income.
  • Draw-down strategies for retirement assets.
  • Retirement planning that includes the impact of future inflation and taxes.
  • A realistic estimate of career duration. Many women assume they’ll work beyond normal retirement age, but more than 40% of Americans retire earlier than they planned to, usually due to job loss, poor health or family needs.

Ms. Hounsell also outlined suggestions for lawmakers to help women attain economic and financial security with legislation designed to:

  • Protect, preserve and strengthen Social Security, which is critical to the financial well-being of women.
  • Support employer plans.
  • Recognize the difference in employment experience between men and women and promote individual saving behavior.
  • Enable later retirement and support better work options at later ages.
  • Encourage financial product innovation that helps older Americans preserve and protect their retirement incomes and assets.
  • Educate women of all ages about financial products, financial planning and saving.

Both men and women need more basic resources to help them determine how much they need to increase their savings for a secure retirement, Ms. Hounsell observed.

Auto features key for small firms

Brigitte Madrian, a professor at Harvard’s Kennedy School, noted that DC participation is a big problem in small firms, which are less likely than larger firms to offer a retirement savings plan and, if they do, are much less likely to use automatic enrollment. “Policy initiatives that encourage and facilitate the automatic savings of employees in small firms are a key step in increasing participation and improving outcomes in a DC retirement savings system,” she said.

She contended that programs such as the Automatic IRA and the HELP Committee’s proposed USA Retirement Funds would create a simple, low-cost mechanism for small employers to make contributions to retirement savings accounts through payroll deduction. She also suggested three ways to boost plan contribution rates, which are often too low:

  • Encourage employers to change the structure of their employer match to provide a financial incentive for employees to save more — for example, by changing the match from 50% of up to 6% of pay to 30% of up to 10% of pay.
  • Encourage employers to adopt a higher default contribution rate under automatic enrollment — for example, 6% instead of 3%.
  • Adopt more aggressive automatic contribution escalation — for example, 2% instead of 1% a year until employees are contributing 10%.

“Leakage” from plans — money taken out of accounts before retirement for other purposes — is also a serious problem. Ms. Madrian suggested a policy that either:

  • Encourages participants to contribute at higher rates than those needed to fund retirement to compensate for preretirement withdrawals.
  • Limits preretirement distributions from these accounts.

Another shortcoming of the current system, Ms. Madrian observed, is that most employer savings plans don’t offer an annuitization option to help employees transition retirement wealth into retirement income. Employers already provide valuable services to their employees by evaluating savings plan investment options, selecting those best suited to their needs and offering lower-cost group investment options through economies of scale. She suggested that employers could also provide the valuable service of offering retirement income options, although they currently have little incentive to do so.

Protecting the pyramid

The Investment Company Institute (ICI) submitted written testimony urging the HELP Committee to avoid actions that would impair the ability of the voluntary employer-provided retirement system to provide Americans with retirement resources, thus risking the success the system has achieved to date.

ICI suggested that rather than the traditional three-legged stool representing Social Security, employer-sponsored pension plans and private savings, retirement resources are more accurately depicted as a pyramid with five potential components, depending on individual wealth:

  • Social Security
  • Home ownership
  • Employer-sponsored retirement plans, both DB and DC plans sponsored by private sector and government employers
  • IRAs (including rollovers)
  • Other assets

Based on data from 1975 to 2011, ICI also disputed the common assumptions that the transition from DB to DC plans has already caused a drop in income and that it will lead to a drop in retirement income in the near future. ICI maintains that:

  • The voluntary employer-provided retirement system is characterized by innovation and flexibility, citing payroll deduction, employer matching, automatic enrollment, auto-escalation and use of target-date funds, among other features.
  • American workers show strong support for the DC system.
  • Changes in retirement policy should build on the existing system, not put it at risk. In particular, ICI recommends the HELP Committee focus on these policy objectives and improvements to ensure successful retirement for as many American workers as possible:
    • Foster innovation and growth in the voluntary retirement savings system, such as further promotion of electronic delivery of plan information, interactive educational tools and materials to help American workers understand their savings options and manage their retirement assets and income.
    • Ease the burdens of plan sponsorship and offer simpler plan features for small employers.
    • Support flexible approaches to retirement saving.
    • Recognize the importance of Social Security and ensure that it remains a strong foundation for retirement security.

The testimony concluded, “Any changes that are made should build upon our existing and successful system so that it works even more effectively to facilitate retirement preparedness for American workers and their families.”

Pension reform top priority

While the political parties have been at odds recently over a number of issues, there is legitimate hope that they can come to a meeting of the minds on retirement issues. Sen. Tom Harkin (D-IA), chairman of the Senate HELP Committee (and a retiree himself as of the end of his current Senate term), observed at the beginning of the hearing, “I am making pension reform a top priority in this Congress for the committee. Fortunately, retirement security has always been an area of great bipartisan concern, so I look forward to working with my colleagues on both sides of the aisle to forge a productive way forward.”

Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under US federal tax laws. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation.

The opinions in this piece are those of the author and are not necessarily those of Invesco. Information in this report does not pertain to any Invesco product and is not a solicitation for any product.

Invesco Distributors, Inc.

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