Investing March 7, 2016

Retirement Portfolio Growth Will Be Lower

JP Morgan researchers suggest 7% or 8% annual return assumptions have very little chance of holding out in coming years and decades.

Reported by

JP Morgan Asset Management’s Global Head of Retirement Solutions Anne Lester has a pretty clear warning for any institutional or individual retirement savers doing predictions with a 7% or 8% annual return assumption baked in.

“Looking at the themes that have come to define the investing markets of the last several years, and looking forward to what we know will be the case in the coming decade, achieving a 7% or 8% annual return target will be a very challenging, if not impossible, objective for portfolios to achieve,” Lester says. “Anyone still expecting to get 8% returns per year is likely to be disappointed.”

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

Lester, who was recognized as Morningstar’s 2015 Fund Manager of the Year, points to a by-now familiar laundry list of global factors weighing down macroeconomic growth. Whether talking about challenging tax and demographic issues in developed economies or stalling growth in emerging markets and China, there is no shortage of headwinds to account for, she explains, “such that growth will almost certainly be lower in the coming decade than the past decade.”  

It’s not all bad news, though. Lester predicts some aspects of the near- and medium-term economic future will be unpleasant for most investors to face, “but it won’t be terrible.” Another way to put it, “6% will be the new 8%.”

Chief Retirement Strategist Katherine Roy agrees, noting that in the 2016 Guide to Retirement publication—the fourth update in the major research project—all return assumptions have been notched down, from “a somewhat conservative 7% for a traditional 60/40 portfolio to an even more conservative 6.5%.”

NEXT: Solutions for a tough future 

“It’s an obvious implication, but this means it’s going to take more dollars invested today to reach the same target later down the road,” Roy explains. “Perhaps even more worrisome is the average annual return we are anticipating for portfolios tailored for those folks already in retirement. That’s going to be more like 5%, if not less, in the coming decades, due to the added inefficiencies of having to carry more cash and of taking less investment risk.”

Roy observes that just shaving 50 basis points off the anticipated annual return for retirement savers has major implications for how much people should be saving today. She points to one of the most commonly referenced pages from the Guide to Retirement (page 15 for those looking at the report) to make the point.

“So if we consider our retirement savings checkpoints analysis, which tells a person how much they should have saved at a given age to be on track for retirement as a multiple of current salary, the new return assumption has really shaken things up,” Roy explains. “In last years’ guide, we found that a 40-year old hoping to replace a $100,000 annual salary by the normal retirement age should have had 2.0-times the current salary saved, or $200,000. In the updated guide for 2016 relying on the 6.5% return assumption, that multiple jumps to 2.6-times current salary, for a $260,000 savings target by age 40.”

In other words, to be considered on track for full income replacement another $60,000 would be needed over what was assumed last year. “This is clearly going to be a conversation starter between advisers, plan sponsors and their participants,” Lester adds.

NEXT: Tax issues are increasingly worrisome

One concrete strategy shared by Lester and Roy to start tackling this challenging return picture is to encourage retirement plan participants to get much smarter about how they will pay the taxes they’ll ultimately owe on accumulated retirement assets.

As Roy observes, the impact of basic-seeming tax decisions, such as going with a traditional versus Roth 401(k), can have massive wealth implications later on in life. “Even today, at a time where many more employers are standing up and taking responsibility for their workers’ retirement prospects, serious misunderstanding about retirement tax deferrals remains,” Roy says. “Many people saving in 401(k) plans today are doing nothing whatsoever to plan for how they will pay the taxes on their distributions.”  

In all likelihood, a given individual will see a big chunk of their defined contribution (DC) plan wealth going to the federal and state governments—likely more if they don't make a sensible plan. “For example, even at a very modest 15% tax rate, a $500,000 portfolio is really only worth $454,000 in spending power for the individual,” Roy says. “Depending on the state where one lives and other factors impacting their tax burden, the tax impact can be absolutely massive.

“Fortunately, tax risk is one of the risks the individual retirement saver can actually control,” Roy adds. “We strongly advocate that individuals work with an adviser, especially during their 50s and 60s, to properly plan how they will pay down their taxes in retirement. Often individuals face a far more difficult tax burden than they anticipated during the planning phase.”

A full copy of the 2016 Guide to Retirement is online here. 

Benefits March 7, 2016

Should Multiemployer Plans Be Replaced by 401(k)s?

This was one suggestion made by a witness at the U.S. Senate Committee on Finance hearing about multiemployer pension plan reform.
Reported by

During a hearing held by the U.S. Senate Committee on Finance, the main issue was the benefit cuts allowed for certain plans under the Multiemployer Pension Reform Act (MPRA).

Under the MPRA, plans that are in “critical and declining status” are allowed to avoid insolvency by reasonably cutting benefits, including those already in pay status. They must apply to the Treasury for permission to cut benefits. Currently, the Treasury has three requests it must consider. 

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

The committee heard from Mrs. Rita Lewis, a beneficiary of the Central States Pension Plan—the first plan to request permission to cut benefits. Lewis noted that Central States says the average cuts are around 22.5%, but other plan members she’s talked to have been told their cuts will be 40% to 70%. She shared stories of plan members or beneficiaries who will be affected by these cuts and are unable to return to work or are too old to make up the loss from investments. Some are considering selling their homes.

But, in his testimony, Joshua Gotbaum, guest scholar, Economic Studies Program, The Brookings Institution, and former director of the Pension Benefit Guaranty Corporation (PBGC), said the alternative to a planned benefit reduction under the MPRA is even worse. “What MPRA did was to allow plans that otherwise would fail entirely to preserve benefits and keep them from falling all the way to PBGC levels,” he said.  “Under MPRA, severely distressed plans can propose a plan to cut benefits, but in every case a participant gets at least 10% more than what PBGC would provide.”

Gotbaum contended that in many cases, vulnerable participants suffer no cuts. For example, in the Central States proposal currently being reviewed, about one-third of participants would suffer no cuts at all.

NEXT: Solutions other than benefit cuts

“Without MPRA, Central States and other distressed plans will become insolvent—and most participants’ pensions will be cut far more,” Gotbaum continued. “Even worse, the insolvency of Central States would completely drain PBGC’s multiemployer reserves, so participants would end up being cut far below PBGC guarantee levels. One analyst estimated that, if PBGC becomes insolvent, ongoing premiums would only cover about 10% of Central States pension benefits—that would mean a 90% cut.”

Gotbaum advocated for higher PBGC premiums for multiemployer plans, saying the agency has insufficient funds to implement actions allowed by the MPRA to help distressed plans—merging plans or partitioning plans.

Witness Dr. Andrew G. Biggs, resident scholar at the American Enterprise Institute, offered what he calls a solution to the problems with multiemployer plans: switching to robust defined contribution (DC) plans. “If employers wish to provide a solid plan to supplement their employees’ Social Security benefits, they can take advantage of recent enhancements to defined contribution retirement plans,” he said.

He noted that most employers now automatically enroll participants in plans, and most participants are in professionally managed target-date funds (TDFs), which automatically reallocate their portfolios to reduce risk as they approach retirement. He cited a Vanguard study that “showed that, for the five-year period ending in 2012, individual investors holding target-date funds earned the same return as state and local pension plans, which supposedly are much more sophisticated investors.” Biggs also pointed out that fee pressure has pushed down costs for DC plans and introduced more low-cost investments. Finally, he noted the Treasury Department has enacted regulations making it easier for 401(k) plans to incorporate annuities, which convert lump sums into a guaranteed income that lasts for life.

“What employees need are well-designed, well-run defined contribution plans that offer automatic enrollment at responsible contribution rates coupled with simple and low-cost investment options such as target-date funds,” Biggs concluded.

«