Special Report on Pension & Retirement Benefits Playing Catch-Up

Employers with defined-contribution plans have a lot of work to do this year.

That is probably not what company executives want to hear after suffering through the nastiest market tailspin in recent history. But here’s the problem: To avoid workers lingering longer in their jobs just to beef up their retirement accounts, employers need to be better problem solvers and get workers to save enough money to be self-sustaining through retirement. That has been the core issue ever since defined-contribution plans became the No. 1 way employees save for retirement.

The baby boomers’ imminent arrival at retirement age, coupled with low returns from the bear market of 2008 and early 2009, is forcing employers to face up to this new demographic risk and how it may affect their business.

“This is the first time I’ve heard [plan] sponsors say they are worried about employees hanging on to jobs,” says Robyn Credico, senior retirement consultant at Towers Watson in Arlington, Virginia. “They are faced with a different kind of volatility and all they are trying to do now is help people save more.”

That means a lot of things on the to-do list for employers, and there is evidence many are gearing up to focus on retirement this year.

A major factor in encouraging employee participation in defined-contribution plans is the employer match, but 12 percent of companies froze those in 2009. Now, 35 percent are bringing the match back, studies from consulting group Towers Watson showed. Of those companies reinstating the match, 70 percent said it’s going back to the original level.

    Additionally, three major trends have significantly accelerated and have helped many workers’ defined-contribution accounts weather the worst of the financial tsunami. That trio is automatic enrollment, the use of default investments such as target-date funds, and the automatic escalation of employee contributions of funds. All were made easier by the 2006 Pension Protection Act and show signs of continuing a remarkable upward trend, helping employers provide a meaningful way for employees to save, observers say.

Plans put to the test
To show how automatic enrollment, diversified investments and solid contribution rates can work even during the worst of times, Vanguard Group found only a 14 percent median decline among its 3 million participants in 2,200 defined-contribution plans in 2008.

Pre-retirees ages 55 to 64 saw a 16 percent median decline. Those invested heavily in stocks took major hits, but workers who regularly contributed to their funds and invested in glide-path or target-date funds fared much better, the study found. Compare this with the Standard & Poor’s 500 stock index, which dropped 37 percent in 2008.

“I don’t think there is any question that [the Pension Protection Act] provisions have set people up to succeed,” says Ann Combs, head of Vanguard Strategic Retirement Consulting. Combs was the assistant secretary of labor for pensions during the George W. Bush administration when the law passed. “PPA has improved people’s ability to save for retirement.”

The number of plans using automatic enrollment has more than tripled since 2005, according to a recent survey by Hewitt Associates Inc. Of the plans using automatic enrollment, nearly 70 percent use target-date funds as the default. The survey of 300 midsize to large employers shows more companies are automatically contributing funds for employees. Forty-four percent of those companies annually increase the original contribution amount, and 5 percent are planning to implement an automatic increase this year, Hewitt found.

Despite concerns that employees would opt out if their contribution rate got too high, Hewitt found that less than 10 percent of employees did so, no matter the rate, says Pam Hess, director of retirement research. “If you escalate by one percentage point a year it’s a pretty painless way to get people to save more,” Hess says. “Our research implies companies could start the default at 6 percent.”

Easier access, more options
In step with the upward trend of many Pension Protection Act features, companies are looking to strengthen other 401(k) elements this year, including faster entry to plans, investment options and employer-contribution options.

   Target Corp., for example, is changing the way it delivers matching contributions starting this month. The Minneapolis-based retailer matches up to 5 percent of eligible pay, and employees are immediately 100 percent vested. Starting this month, Target is allowing employees to invest the employer match directly into any of the 20 available funds or company stock, instead of putting the company match solely into its stock.

Target’s move is in line with Hewitt’s research showing fewer employers making matches in company stock. Only 17 percent of employers did that last year, compared with 23 percent in 2007.

“This change is being made to give team members additional options to ensure their account is appropriately diversified for their needs,” company spokesman Trace Ulland said in an e-mail.

Target’s $4.5 billion 401(k) plan has about 140,000 participants with an average account balance of about $32,000. A new “Retirement Readiness” index created by Fiduciary Benchmarks, a company in Portland, Oregon, shows Target employees are 101 percent ready to retire.

Tinkering with career development or recognition programs will not suffice for employees who have swallowed outright pay cuts or faced freezes representing the permanent loss of the average 3 percent pay increase that would have occurred in 2009 if employers had left pay programs intact. When the workforce is soured over pay cuts, only money talks.

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To speed automatic enrollment, more companies are eliminating or lowering the service requirements needed to gain entry to the plan. Hewitt found that 74 percent of 401(k) plans didn’t have a service requirement last year, which is steadily climbing from 61 percent in 2007.

Meanwhile, there is no slowing down the use of target-date funds, according to several studies. Nearly 58 percent of companies used them in 2008, up from 44 percent in 2007, the Profit Sharing/401k Council of America reported in its annual study.

Larger employers, such as Wal-Mart Stores Inc., are starting to use a custom-designed target-date fund to fine-tune the retirement needs of its 1 million 401(k) plan participants. The company says the move will help keep management fees low as well as give it more asset allocation and other types of managerial control.

And while this type of fund has received scrutiny because of fee variation and transparency issues, observers agree that over time, these glitches will be worked out.

“Target-date funds are not as sophisticated as they’re going to be in the future,” says David Wray, president of the Profit Sharing/401k Council of America. “We need more history to see how they go through up and down periods.”

Guaranteed income
Annuities that are built into the 401(k) plan are a new investment option being explored by employers that are looking for fixed-risk protection—not just from investments going bad, but also from retirees outliving retirement income.

One of a handful of managers offering an income guarantee is Prudential Financial Inc. IncomeFlex locks a specific income throughout an individual’s lifetime in retirement. The account automatically tells participants exactly what their retirement income will be once they reach a certain age. Employees can’t lose money in the investment, even when markets turn sour.

Since this is a new type of investment, it will take time for it to gain popularity, says George Castineiras, senior vice president for Prudential Retirement. Nevertheless, Castineiras says, “I am very optimistic this is going to take off.”

And while guaranteeing an income stream throughout retirement is a great idea, it still needs development, some observers say. After seeing numerous financial institutions tank during the recession, many plan sponsors worry about the inherent long-term relationship such an investment requires.

“There is some very sophisticated thinking going on here,” Wray says. But he adds that some issues—notably liability and portability—haven’t been completely resolved.

After seeing several banking companies tank during this recession, investors are unsure whether it’s wise to make a long-term commitment with one provider. They question of what will happen if a provider goes out of business is unclear, Wray says.

“Especially with what we’ve experienced with financial institutions, no one is 100 percent sure about making 50-year decisions like this,” he says.

Portability presents the question of what to do if an employee moves on to another job. Currently, the annuity either remains at the former employer, to be tapped at retirement age, or its assets can be converted and rolled into an individual retirement account.

“Plan sponsors are very interested in finding out whether there are better ways to service participants,” Wray says. “Clearly conversations are going on and plan sponsors are moving in the right direction.”

Workforce Management, January 2010, p. 23-26 — Subscribe Now!