The biggest issue these days for investment advisors and financial planners is retirement planning. If you ask retirement planning professionals what the biggest retirement issues are this year for advisors, plan sponsors, and plan administrators, they'll collectively nod that adhering to provisions of the Pension Protection Act (PPA) will monopolize a great deal of their time. If you ask them which PPA provisions concern them most, they'll likely say automatic enrollment, fee disclosures, providing investment advice to plan participants, and selection of default investment options in 401(k) plans.
Let's not forget, however, that there are other retirement issues that will consume a significant portion of advisors' time in 2007, namely the ever-increasing need for advisors to find income for retiree clients, particularly Baby Boomers. The debate on whether annuities are the superior income-generating vehicles of choice for advisors will likely rage on. Some advisors argue in favor of annuities, saying it's really the only option, while others prefer alternative methods of generating income for clients. Still other advisors believe that getting up to speed on helping their retiree clients tackle healthcare-related issues will be a pressing task this year.
Passage of the PPA last August was a watershed event that confirmed what retirement officials say is the sea change that's occurring in the retirement planning industry: defined benefit plans are falling by the wayside as defined contribution plans, including 401(k) plans, become the dominant retirement savings vehicles. The findings of Cerulli & Associates in its "State of the 401(k) Marketplace," released in January, bear out this shift. Total assets in retirement plans at year-end 2005 (the most recent numbers available) totaled $13.3 trillion, Cerulli says, with IRAs holding $3.9 trillion and defined contribution plans holding $3.8 trillion. Defined benefit plans, meanwhile, make up the remaining $5.61 trillion. However, $2.8 trillion of the DB total is in state and local government DB plans, while only $1.9 trillion is in private DB plans, which continue to shrink. The remaining $0.91 trillion is in federal DB plans. In 2005, there were almost 55 million participants in DC plans, an increase of more than one million from the previous year, Cerulli says. The Boston-based research firm predicts that the PPA's support of automatic enrollments and the retirement industry's movement toward auto enrollments will continue to boost the number of 401(k) participants in the next five years.
Enrolling Automatically
Indeed, the impetus for auto enrollment, says Steve Utkus, principal at the Vanguard Center for Retirement Research, has come from "large companies who've been concerned about specific fiduciary issues like how to choose the default [investment option] and how to avoid state anti-garnishment rules." It will be the medium- and large-sized firms that "find it hard to promote their plans," Utkus says, and that will be quick to adopt auto enrollment in the near term, as opposed to smaller companies. "Smaller companies tend to have higher participation rates" in their retirement plans, he says. However, those advisors who service small company plans will need to be savvy about the auto enrollment rules–both the safe harbor as well as the traditional auto enrollment rules–he warns, as some small firms will jump on auto enrollment. "There will be an increasing emphasis on auto enrollment [from large companies], and eventually it will trickle down but I don't think there's an immediate sense of urgency where advisors need to be out talking to clients about shifting from a voluntary plan to an automatic enrollment plan," Utkus says.
A group of attorneys at the law firm of Reish Luftman Reicher & Cohen in Los Angeles agree, in their recent bulletin on automatic enrollment, that large and mid-sized plan sponsors are likely to be quicker in embracing this option. They go on to note that approximately 20% of the largest 401(k) plans already automatically enroll participants.
On a related note, The Retirement Security Project is urging Congress to establish a payroll-based automatic IRA program as lawmakers review the Bush administration's 2008 budget proposal. The group says the automatic IRA, which it proposed last year, "could bring millions of people into the retirement saving system and increase net national saving by an estimated $8 billion annually."
Defining Default
You can't talk about auto enrollment unless you also discuss default investment options. The PPA requires that the Department of Labor (DOL) create new rules within six months of the Act's passage which will detail exactly what constitutes an appropriate default option within a 401(k) plan–the so-called Qualifying Default Investment Alterna-tives (QDIAs). At press time, DOL said that it would not issue final rules on QDIAs by its February 17 deadline. However, DOL's proposed rules indicate that the QDIA must be a target date fund (lifecycle fund), balanced fund (lifestyle fund), or a managed account. Louis Campagna, chief of the Division of Fiduciary Interpretations and Regulations at DOL, said in late January at the ALI-ABA investment advisor regulation conference in Washington that DOL is now reviewing the more than 1,000 comments it received on the QDIA proposal.
Matt Smith, managing director of Russell Retirement Services, says if DOL sticks with the three investment choices, he thinks the majority of plan sponsors will "go the target date route," because the funds offer a "simple, sensible, elegant way to default your participants."
Target Funds Can Take Away Participant Worries
Why do target date funds make the most sense? Smith offers this simple explanation. When 401(k) plans first hit the scene a few decades ago, employers were solely responsible for investing all of a participants' money, leaving participants with basically no say in the matter. Then the pendulum swung in the other direction to the point where employees have been given too much choice, Smith says, and participants have been bombarded with too many investment selections. Now, with PPA, "we're kind of swinging back to this equilibrium where it's the responsibility of both employer and employee to invest properly," he says.
Given the fact a number of behavioral finance studies have shown that retirement plan participants are either "uninterested or ill-equipped to make sensible investment decisions," Smith says, it stands to reason that target date funds are becoming popular because they require "no work on the part of the participant." With target date funds, "participants know how long they have until they retire, they're choosing a target date fund that matches up to that retirement date, or they are being defaulted into it by their employer by making no decision–at that point, within the fund, the asset allocation decisions are made for them, and they are managed over time and supervised."
A number of critics have argued that one of the problems with target date funds is that they lump all types of investors together, regardless of their risk tolerance and financial situation. But Smith, for one, says that most participants either don't have the time or are anxious about choosing an asset allocation for their retirement accounts, so by choosing a default option, they're consciously asking someone to do it for them. "When we're talking about a default, it's for participants who have chosen to not [choose an allocation] for some reason," Smith says. "If that's the case, I don't think it's a fair criticism to say we're lumping all these people together. They are actually lumping themselves into that do-it-for-me category."
