Building on Success – What’s Next?

After all, in the not-so-distant past, plan participation was low, utilization of diversified options was somewhat limited and the overall industry lacked a broad toolset to effectively improve participant outcomes.

Today, the retirement industry is taking steps—and getting results—that we would have never dreamed of 10 years ago. In fact, improved DC plan designs are now commonly embraced; participation is steadily improving and retirement plan balances are up. DC plans have taken center stage, with $6.6 trillion in retirement assets serving as the foundation for current and future retirement security.[1] 

The first step in overcoming the plague of employee inertia was auto-enrollment, which effectively harnessed the tendency of participants to freeze in the headlights of complexity and choice. Plan sponsors, advisers and recordkeepers are now using increased starting deferral percentages, auto-escalation, improved matching structures, fund mapping and re-enrollment to help participants effectively accumulate retirement savings.

How can we as an industry—investment managers, plan providers, employers, policymakers and even participants—continue to challenge conventional thinking? In 10 years, what innovations will we point to that provided additional improvements in retirement security?

In this first part of a continuing series, we will frame up three issues we currently face, and suggest approaches that, while unconventional, could broadly improve retirement security.

Enhanced Diversification for Better Risk Management

How much of the retirement savings shortfall can we erase with improved portfolio diversification? For example, an additional 50 basis points of return (net of fees) on the $6.6 trillion currently in the retirement system would provide an extra $33 billion per year to help stabilize retirement security. We believe this is achievable.

With the prevalence of auto-enrollment provisions, target date funds (TDFs) have captured a large percentage of flows, unintentionally (but positively) increasing overall diversification. However, more diversification does not necessarily translate to optimal diversification.

When assessing portfolio asset allocation goals, consider DC plans in aggregate, as a large pool of capital rather than as collections of relatively small balance accounts. Would we diversify risk differently? For defined benefit plans or large endowments, the answer is an unqualified “yes.”

Historically, institutional accounts have built more diversified portfolios, including a more global perspective for both equities and fixed income. Large endowments are leading the way with alternative investments (54% versus 15% for large pension plans), increasing diversification and managing downside risk.[1] Meanwhile, DC plan use of alternative investments remains stubbornly close to zero. We need to carefully consider diversification and asset class exposure for TDFs, whether through custom structures or off-the-shelf mutual funds. We believe that improving both options will most effectively deliver the benefits of a more sophisticated asset allocation approach to the greatest number of participants.

Solutions for Participants Moving from Accumulation to Distribution

What if your entire pool of participants accumulated adequate savings at retirement, but a substantial minority still had to scrape by on Social Security late in life? As an industry, we need to turn our attention to helping participants convert their accumulated assets into retirement security.

In-plan solutions to manage this transition and address issues such as longevity risk can help participants achieve better outcomes. Failure to adequately provide better investment tools and plan design options can jeopardize hard won gains.

For younger participants who have the luxury of time, sub-optimal asset allocation can still be corrected with relatively straightforward interventions. For individuals closer to retirement, the situation is less benign due to shorter and less flexible time horizons. For them, inflation presents a pesky and pervasive dilemma. How can we resolve a much-reduced tolerance for volatility with the need to keep up with ever-increasing prices?

Broader Coverage Is Not as Simple as It Seems

Let us be clear; if even one worker remains uncovered by a retirement plan, it is one too many. While the headlines correctly report that many workers are not covered by a plan, overly simplistic analyses mask important distinctions and can lead to faulty proposed solutions. While 74% of full-time, private-industry workers have access to a retirement plan,[1] a significant portion of workers—especially part-time workers—currently have no access to a retirement plan at work.

We must understand the interim nature of coverage; a majority of those not currently covered will pass through periods of coverage and non-coverage.  In an era of high worker mobility, effective solutions must stitch these coverage periods together, providing continuity wherever possible.

Resolving coverage challenges may require nuanced and flexible solutions that move beyond blanket remedies. As an industry, we must be deliberate in addressing coverage issues and to find meaningful strategies that will provide retirement access to the broader population, without harming the existing system.

As an industry, we must continue to innovate and challenge conventional thinking. Plan sponsors are seeking better solutions and participants need our help. We have to lead the way.

So we ask ourselves: what’s next for retirement plans? What tools and strategies are best positioned to address the retirement challenges of today and tomorrow?

Our subsequent articles will explore new thinking on specific solutions. Ultimately, thorough exploration of these issues should help find a path to even more positive outcomes for all of us. 

Authors:

Drew Carrington, senior vice president, head of Institutional Defined Contribution in the U.S. for North America Advisory Services for Franklin Templeton Investments  

Yaqub Ahmed, senior vice president and head of Investment-Only Division-U.S. for North America Advisory Services for Franklin Templeton Investments  

Michael Doshier, vice president of Retirement Marketing for Franklin Templeton Investments