Designing Successful Target-Date Strategies for Defined Contribution Plans: Putting Participants on the Optimal Glide Path: 594 (Wiley Finance) - Hardcover

Schaus, Stacy L.

Hardcover

ISBN 10: 0470596317 ISBN 13: 9780470596319

Publisher: Wiley, 2010

Synopsis

The ultimate guidebook for navigating the new world of pensions and retirement plans

In the wake of the explosive growth of defined contribution (DC) plans invested with target date strategies, and the understanding of how important these strategies can be in effectively meeting retirement income goals, plan sponsors are seeking more optimal target date approaches. This timely book provides you with in-depth answers from the nation's most qualified and experienced experts to pressing questions about DC plan design.

• Presents the views of individuals from all across the market
• Includes a broad range of plan sponsors both in the corporate world and in the public/government sectors
• Offers views from consultants and advisors from the most respected firms, academics who teach at leading universities, and other innovative leaders

With a broad range of knowledge and insight, Designing Successful Target Date Strategies in Defined Contribution Plans helps you understand the evolution of DC plans, pulls together all angles of what it takes to develop custom target date strategies, and provides you with a look ahead to the future.

About this title

About the Author

STACY L. SCHAUS, CFP, is a senior vice president and the defined contribution practice leader at PIMCO, which manages over $130 billion in DC assets. Prior to joining PIMCO in 2006, she was a founder and president of Hewitt Financial Services LLC, where she created the Hewitt 401(k) Index. Ms. Schaus has nearly thirty years of investment experience. She has written extensively on defined contribution issues, including PIMCO DC Dialogue, and has been named by 401kWire as one of the fifty most influential leaders in defined contribution for 2010. Stacy is the Founding Chairperson of the Defined Contribution Institutional Investment Association, as well as a board and research committee member for the Employee Benefit Research Institute. She also is a former board member of the Financial Planning Association.

From the Back Cover

Your nuts-and-bolts road map to understanding how to create custom target-date strategies

One of the hottest investment products of the past few years, target-date retirement funds have taken hold in the world of 401(k) and other defined contribution plans, forcing you, as a plan administrator or sponsor, to rethink your program.

Written by one of the nation's most qualified and experienced experts in the field, Designing Successful Target-Date Strategies for Defined Contribution Plans gives you the detailed answers you need to your questions about defined contribution plan design and building custom target-date strategies, with in-depth coverage of:

• Defined contribution plans in the American retirement system

• Evolving DC plan design

• Target-date strategies: packaged versus custom

• Legal and fiduciary considerations

• Recordkeeping and trust setup

• Communication issues

• Evaluating costs

• Glide path design

• Asset classes and alternatives

• Protecting DC assets

• Benchmarking

• Advice and retirement planning

• Retirement income and guarantees

Since target-date strategies place participants on "autopilot," you need to take a good, long look at what you offer so you can confirm that participants will arrive at the right destination. Designing Successful Target-Date Strategies¿for Defined Contribution Plans demystifies the often daunting and confusing task of understanding these retirement investments, with sound advice from experts across the industry on the best way to design your own asset allocation, keep plan fees at the lowest possible level, and help protect both plan participants and sponsors from risk.

From the Inside Flap

Over the last decade, there has been a revolution in the way that retirement plans have been conceptualized and set up in America. Defined contribution (DC) retirement savings plans have rapidly become many organizations' sole sponsored retirement vehicle, providing participants a primary source of retirement savings beyond Social Security. With the amount of money going into these plans―over $3 trillion in assets―increasingly being invested in target-date retirement strategies, investment managers, consultants, advisors, record keepers, and many others are wisely clamoring to capture these assets and generate other significant business from these game-changing entrants.

Taking a closer look at target-date strategies from all angles, Designing Successful Target-Date Strategies for Defined Contribution Plans provides you with the support you need to design best-in-class target-date strategies for DC plans. Practical and detailed, this thorough book considers the current relevant trends in plan design with coverage of:

• The expertise of many of the nation's leading consultants, legal experts, plan sponsors, academics, and others

• Various perspectives and innovative approaches to designing optimal DC plans

• The history of the development and restructuring of retirement plans in America, especially in light of the Pension Protection Act and recent regulations

Written by Stacy Schaus, a renowned defined contribution business leader who deals with these issues on a daily basis, this book explains it all, from the evolution of DC plans and design trends, including the development of target-date strategies, to the benefits of building rather than buying an off-the-shelf product, as well as all you need to know to set up your own custom strategies. This nuts-and-bolts book is designed to help you build a successful retirement program that will help manage risk and ultimately foster a dignified and secure financial future for employees of corporations, not-for-profits, governments, and for yourself as well.

Excerpt. © Reprinted by permission. All rights reserved.

Designing Successful Target-Date Strategies for Defined Contribution Plans

Putting Participants on the Optimal Glide PathBy Stacy Schaus

John Wiley & Sons

Copyright © 2010 John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-59631-9

Chapter One

DC Plans in the American Retirement System

Someone once called defined contribution (DC) plans one of the "great social experiments of our time." For many people, a DC plan is the only company-sponsored retirement plan they have, and for this reason, plan effectiveness needs to be more than merely an "experiment." People need these plans to function because most will depend on them to provide adequate retirement income. The plans should also be designed to realistically take into account factors such as inflation.

When we refer to DC as a social "experiment," we should recognize that "scientists" in the retirement-plan field have made significant contributions to the status of DC plans today. Two behavioral economists who have done so are Professor Richard Thaler from the University of Chicago and Professor Shlomo Benartzi of the University of California at Los Angeles. Perhaps their greatest DC contribution has been to support automatic programs within the Pension Protection Act (PPA). Working from the premise that inertia is one of the most powerful forces of nature, employee auto-enrollment, auto-contribution escalation, and auto-asset allocation all work together to help put Americans in a better position to retire more successfully.

We need to find better ways to make these retirement plans succeed. What is more, each participant must succeed in a retirement plan individually. In other words, it is not good enough for a group of employees to reach their retirement-income goals on average.

Some people will resort to anything to find a creative solution to retirement planning. We saw an extreme example in the 2007 New York Times article "A Financial Plan that Comes with Mug Shots." The story involved "financial visionary" Timothy Bowers, who solved his retirement income shortfall by robbing a bank and immediately handing himself over to the police. Bowers figured that if he were sentenced to a minimum-security prison with "quality programming for an aging offender population" and remained in jail until Social Security and Medicare kicked in, he would be able to meet his retirement-income goal.

Few of us are desperate enough to go to that length. However, this story underscores the need for our retirement plans to succeed, again, not just for most people but for everyone individually. That is why we produced this book, covering key issues in today's retirement field. To gather a wide variety of experienced commentary on these issues, in 2006 we started the monthly PIMCO DC Dialogue series in which we interview various retirement experts, including consultants, academics, plan sponsors, financial advisors, attorneys, and others. This book discusses a number of points from conversations with them and covers key questions and proposed solutions discussed at the Pensions & Investments Custom Target-Date Summits held in both 2008 and 2009.

EVOLUTION OF DB AND DC PLANS

To see where you are going more clearly, it is helpful to understand where you are coming from. For that reason, we asked David Wray, president of the Profit Sharing/401(k) Council of America (PSCA), to share some historical background about the evolution of DC plans in America. Wray explained that while most people think that DC plans began with the invention of the 401(k) plan, the plans actually got their start in the late 1800s with the implementation of company profit sharing plans for employers "to build partnership in the workplace and manage labor relations."

Procter & Gamble led the way with this type of plan in 1887, but then found that employees were spending the money instead of using it as a financial reserve or as money that could go toward their retirement. So in 1904, "to encourage saving, P&G introduced a stock-purchase and matching program in which they would match contributions made by the employee, with an additional amount based on the profitability of the company." This, Wray noted, was the genesis of company matching.

Then the Revenue Act of 1921 initiated tax advantages for employment-based retirement plans, allowing plan contributions to be tax free until the employee withdrew funds from the retirement account. "This law established the value of the DC plan from a tax perspective," Wray explained, "which remains the real advantage of these plans today."

These early DC plans flourished in the early part of the twentieth century, but when so many companies were forced out of business during the Great Depression, only about 300 plans remained at the beginning of the 1940s. However, World War II marked a rebirth of retirement plans and employee benefits. As Wray noted:

At the time, wages were frozen but there were no government limits on benefit plans. Competing for high-quality-and now scarce-workers, companies improved their benefit plans and started offering both health insurance and retirement programs. There was an increase in both traditional defined benefit plans, with which most people are familiar, as well as DC programs. By the 1950s, the DC system had grown and evolved into three kinds of tax-advantaged plans: pure profit-sharing plans where the employer contributed the entire amount; cash and deferred profit-sharing plans in which companies allocated a profit-sharing bonus to the employee, who could take all or part of it in cash or defer all or part of it into a profit-sharing trust; and thrift savings profit-sharing plans, into which the employee contributed a certain amount of his or her income on an after-tax basis and could receive a tax-deferred employer matching contribution.

The year 1974 saw the creation of the Employee Retirement Income Security Act (ERISA), which focused on defined benefit (DB) funding issues, but also impacted DC programs. "Unfortunately," Wray pointed out, "ERISA failed to authorize the continuation of cash and deferred profit-sharing plans and, as a result, no new plans were formed and some companies withheld contributions waiting for a clarification."

Recognizing that there were at least 1,000 of these plans and that they "were excellent programs for workers to build retirement savings, as well as for companies to build a positive partnership in the workplace," legislation was passed in 1978 to change the tax code and correct this oversight. However, the language inadvertently went further, opening the door "to a new type of deferred compensation savings plan, the 401(k).... For the first time, workers were allowed to save not only bonus dollars, but also regular wages on a tax-deferred basis." Following further clarification by the IRS in 1981, the modern 401(k) plan was born.

In 1982, Wray explained, when companies began to allow "employees who were already making after-tax contributions to the plan to make their contributions on a tax-deferred basis ... the 401(k) then took off like wildfire. Within years, literally millions of people were participating in these programs."

This full-speed-ahead rush to save a significant amount of tax-deferred wages in these plans was not to last. Concerned about lost tax revenues, Washington and the Internal Revenue Service (IRS) first tried to repeal the law but, with the Tax Reform Act in 1986, succeeded only in adding "onerous discrimination tests" and putting a cap on how much employees could contribute annually to a 401(k) plan. "This change in legislation," Wray explained, "led to the termination of most cash and deferred profit-sharing plans, as the new government restrictions made them impractical."

The great irony of this legislation is that Section 401(k) was intended to reinstate cash and deferred profit-sharing plans, but the government's revenue concerns regarding the potential success of 401(k) led to changes that killed cash and deferred profit-sharing plans.

When we asked Wray if he agreed with the general consensus that the Pension Protection Act of 2006 had caused many companies to close or freeze their defined benefit plans more rapidly, he agreed. He also concurred with us that, with so few companies now offering DB plans to workers, 401(k) and other DC plans are more important than ever and are currently undergoing a complete transition. "While they were created initially for profit sharing," Wray explained, "today the employee deferral using the 401(k) has become the predominant form of DC plan. More companies every year are adding the opportunity to save in a 401(k) plan, even those that already offer very rich profit-sharing plans. We're approaching 50 million actively employed workers who have a balance in a 401(k) plan and 60 million in DC overall." Wray is confident that the DC system will continue to grow in the coming decades.

MAKING THE MOVE FROM A DB PLAN TO A DC PLAN

We asked a variety of experts and plan sponsors to comment on how switching from DB plans to DC had changed the face of retirement. Deena Katz, associate professor at Texas Tech University, Personal Financial Planning Division, speaks about how having more than one choice in terms of retirement accounts has changed the way that they communicate with clients regarding their responsibilities. Almost 30 years ago, Katz related, when she first began in the retirement-planning field, there were DB plans "that could take care of a good percentage of a person's retirement-income needs." Some of the plans even included cost-of-living adjustments to help clients keep up with inflation. "Many of us," Katz remarked, "grew up with a three-legged retirement-income stool composed of our DB plan, our own investments including defined contribution, and Social Security. Today, the truth is, we don't know where Social Security is headed. And our company-provided retirement benefits are typically limited to DC." Even in the many cases where DC plans offer a company match, plan participants are still responsible for deciding how much of their salary goes into those plans. "In essence, today we have a two-legged stool that tells us we're on our own in terms of investing for our future. As advisers, we need to help people understand that they must rely on themselves and how to plan, given the available programs and other resources."

However, Tom Idzorek, the chief investment officer at Ibbotson Associates, points out that the shift to DC as the primary retirement vehicle

doesn't necessarily reduce plan sponsors' responsibilities as they pertain to creating the best possible plan. Ultimately, as fiduciaries, plan sponsors still want to create a good lineup of options that enable employees to create their own diversified portfolios to meet their participant needs. In addition to designing a good lineup of single-asset-class fund options, these days we also see more plan sponsors adding a do-it-for-me option-either a target-date, target-risk, or perhaps a managed-account option.

Charlene Mims, vice president of benefits, HRIS and payroll at Dole Food Company, Inc. is creatively looking at the needs of the company's workforce, exploring a somewhat DB-like approach to the DC plan: "Basically we're exploring two directions. One is to give people an additional DC contribution based on years of service. A second is to offer a minimum or floor payout, again, based on years of service." She feels that this somewhat "1970s approach" helps Dole to both attract and retain employees. Since over 50 percent of its workforce will be over the age of 55 within the next three to five years, this payout approach is a benefit that older employees who are nearing retirement find highly attractive.

David Wray of PSCA concurs that there is no such thing as a one-size-fits-all solution and that looking at the unique needs of the population is important in designing the DC plan. "I'd suggest the plan sponsor take a hard look at its workforce and what it's trying to accomplish. Often when companies transition from a DB to a DC-only system, they find very low DC participation. In this case, companies look for ways to make their DC arrangements more successful."

Wray is looking for creative ways to achieve greater plan participation. One approach is auto-enrollment, not only of new hires but of current employees who are not participating. He explains: "While an educational process can work in some cases to raise participation, if you need to really jump-start the system and bring it up to a high level of participation right away, automatic enrollment makes a lot of sense. Auto-enrollment has gained ground rapidly, especially with the recent government support and incentives to add the feature to plans."

Wray also feels that adding "a hybrid, profit-sharing or other employer-funded program in which all employees are participants even if they don't make elective contributions like in a 401(k)" is a good strategy. "The idea ... is for everyone who works at your company to have an account that accumulates money for retirement. There are a lot of different ways to do that. The advantage of the DC system is that you can have a single plan with all these features integrated into it."

Mark Ruloff, the director of asset allocation at Towers Watson, points out that while DB plans continue to be "a key component of retirement security, we see them playing less of a role than in the past." Now DC plans are the primary source of most workers' retirement income, and he notes that recent changes under the PPA have given employers the ability to improve asset allocation and increase participant's savings rates via automatic programs. These default strategies play an important role in an individual's ability to retire. However, like Wray, he does not believe in one-size-fits-all retirement solutions.

When we looked at the different types of target-date funds, we discovered that there's no silver bullet that solves all problems. In working with plan sponsors, we encourage participants to save more and to use an appropriate investment approach. Employers need to educate people to save more rather than simply rely on investment performance to deliver the retirement income that they need in the future. As we know, target-date strategies are garnering a lot of attention and assets. We hope that these asset-allocation strategies, combined with higher savings rates, will help participants better meet their retirement income needs.

HOW DO WE MEASURE DC PLAN SUCCESS?

With all this in mind, it is important to look in more detail at how DC plan objectives have changed in recent years and how plan sponsors are defining "success." Because, as we discussed, plan sponsors now rarely offer a defined benefit plan, creating an effective employee DC plan has become the primary issue. During this transition, the DC plan objective has shifted from wealth accumulation to creating adequate and sustainable retirement income for all participants.

Today only 21 percent of U.S. private workers participate in a DB plan; given this reality, most plan sponsors-about 64 percent-view their DC plans as the primary company-sponsored retirement-savings vehicle. Given this shift, it is important for plan objectives to change.

In one of our first DC Dialogues, we asked Josh Cohen, CFA, and Phil Enochs, CFA, of the Russell Investment Group, "How can a company measure its DC plan success?" Their answer: "A company should examine the retirement income-replacement ratio, a percentage of the pre-retirement income replaced by the accumulated DC savings." They suggested that plan sponsors-especially those that use DC as primary retirement-savings vehicle-should evaluate the realistic likelihood that a plan will provide a sufficient level of income throughout retirement.

When we asked if there was a specific retirement-income replacement ratio that the DC plan should aim for, they said:

Financial advisors often suggest that a participant save enough to replace somewhere between 70 and 100 percent of pre-retirement income to enjoy the same standard of living after retirement. In the past, income replacement came from four primary sources: DC plans, DB plans, Social Security, and private savings. Today, a larger portion of that income needs to come from the DC plan.

(Continues...)

Excerpted from Designing Successful Target-Date Strategies for Defined Contribution Plansby Stacy Schaus Copyright © 2010 by John Wiley & Sons, Ltd. Excerpted by permission.
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Edition details

• Publisher: Wiley
• Publication date: 2010
• Language: English
• ISBN 10: 0470596317
• ISBN 13: 9780470596319
• Binding: Hardcover
• Edition number: 1
• Number of pages: 336