Managing Retirement Benefits in Today's Economy
The recent disruptions in the capital markets have created a new set of challenges for plan sponsors, company leaders, benefit managers, and employees across the country. Employees and employers, now more than ever, need to take the appropriate steps to ensure that prudent decisions are made in respect to employees saving at an adequate deferral rate, establishing an appropriate asset allocation mix, and planning to replace income throughout their retirement. Unfortunately, too many employers do not provide employees the tools necessary to make informed, educated decisions to meet their retirement goals.
These days, employees bear all the investment risk when it comes to participation in a 401(k)/403(b) plan. This is a major change from the past where defined benefit plans were the primary savings vehicle and employers took on all the investment risk. In today’s workplace, employees are more transient and generally do not stay with a company long enough to accrue substantial retirement savings under the defined benefit plan. The Pension Protection Act of 2006 realized that today’s employees need to have a retirement vehicle that can be portable and move from one employer to the next. Even though this legislation addressed the changing landscape of today’s workforce, it did not provide plan sponsors and employees the guidance and direction they needed to make the changes to their retirement plans.
There are a number of investment products and plan features in the marketplace today that plan sponsors can now offer to their employees that address these shortfalls. These enhancements can help increase the odds that the retirement investment and savings needs of plan participants will be met and at the same time will mitigate the fiduciary risk of plan sponsors.
- Automatic Enrollment – In absence of an affirmative election by an employee, the employee is treated as having elected to make a contribution to the employer’s plan in an amount specified by the plan. Automatic enrollment takes inaction on behalf of an employee (not enrolling) and changes it to action (enrolling). Numerous studies have shown that the majority of employees who are auto enrolled stay in the Plan as the hurdle or action needed to enroll is removed.The employee then has the chance to make a subsequent affirmative election to opt out of the plan.
- Automatic Contribution Escalation – The next generation of automatic enrollment plans automatically increases an employee’s salary deferral contribution at a specified time, generally the first day of each subsequent plan year or coincident with pay raises. The Plan can put a cap or a maximum on the escalation (generally from 6% to 10% of compensation) as deemed appropriate for their employee base. Employees always maintain the flexibility to stop these increases or increase or decrease the amounts deferred, as defined by the terms of the Plan. Employees who have their salary deferral contribution automatically increased have been shown to contribute at higher levels than those who need to increase their contributions on their own.
- Target Date Funds - Target date funds (also referred to as target maturity or lifecyle funds) are investment alternatives that are designed to simplify retirement plan asset allocation for plan participants. Target date funds allocate their investments among the various equity and fixed income asset classes and automatically shift that allocation to a more conservative allocation as a “target date” nears. The Department of Labor (DOL) in 2007 issued final regulations that certified target date funds as QDIAs (Qualified Default Investment Alternatives) for qualified retirement plans. This certification provided plan sponsors much needed fiduciary relief in the investing of plan assets on behalf of participants in the absence of an affirmative election.
- Roth Deferral Contributions – The Roth(k) feature allows employees to make after-tax salary deferral contributions to their 401(k) plans. Unlike pre tax salary deferral contributions which provide a tax break at the time of deferral, employees who elect to make contributions on a Roth after-tax basis will enjoy a tax-free distribution if two qualifying features are met. First, the distribution must occur after the participant has attained age 59 ½ unless the distribution is a result of the participants death or disability. Second, the distribution must occur after the 5 year rule has been satisfied. This is a clock that begins on the January 1st of the calendar year in which the participant first makes a Roth 401(k) deferral and ends on the December 31st of the 5 year anniversary of that first Roth deferral. The ability to contribute on a Roth basis within a 401(k) provides added flexibility to hedge against any changes in an employee’s future personal tax rate as well against any future changes to the federal income brackets.
- Guaranteed Income for Life Products – These products, which are relatively new to the market, provide downside protection and income for life to help reduce longevity risk. The market collapse of 2008 has shed additional light on the importance of having an income stream available to participants in 401(k) plans, similar to those inherent in defined benefit plans. The goal of these types of investments is to “turn” an employee’s 401(k) plan into a defined benefit plan, with individuals having a steady stream of income lasting throughout their retirement years. Without this stream of income, employees run the risk of outliving their retirement assets.
- Employee Education Programs – With the continued emphasis of employees bearing most, if not all, of the investment riks, more and more companies are helping their employees make wise investment decisions by offering financial education workshops. These workshops introduce employees to key investment principles such as asset allocation, diversification, income replacement, etc. The sad truth is that an individual will spend more time planning an annual vacation than they will on their retirement planning. With most of the responsibility falling on their shoulders, a continued employee education program is necessary to have a successful retirement plan.
- Distribution Planning Assistance – Employees spend their entire careers working to accumulate income for retirement and now need assistance with strategic planning on how to stretch that money throughout their retirement years. Employees make the transition from the “accumulation phase” in their working years to the “distribution phase” in their retirement years and need the assistance of experienced professional to enact a plan to provide income for the latter stages of their lives.
The information being provided is for general education purposes and with the understanding that it not intended to be used or interpreted as specific legal, tax or investment advice. The scenarios do not address or account for individual investor circumstances. Investment decisions should always be made based on your specific financial needs and objectives, goals, time horizon and risk tolerance. Summit Financial Corporation and its representatives do not provide tax or legal advice to individuals. Consult your tax advisor or attorney regarding specific tax issues.
The materials created through August 2011 are when the professionals of Summit Financial were with Ogilvie Security Advisors Corp. The professionals of Summit Financial have not been with Ogilvie Security Advisors Corp. since August 31, 2011 and have no further affiliation with that organization.