Investing January 25, 2019

The Effect of Market Volatility on Millennials’ Retirement Savings

Millennials need to understand their longer investing time horizon allows them to handle more market risk and even provides certain opportunities for saving for retirement.
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Art by Dalbert B. Vilarino

The market volatility throughout 2018 was one of the first streams of economic chaos to hit some of the workforce’s youngest age group: Millennials.

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Typically touted as the most confident generation in technology, awareness and knowledge, Millennials can find this same confidence concerning the latest market instability. Aside from reports of skepticism in investment vehicles, from stocks to private equity, this class of workers experience the benefits of volatility as they can assume greater risk, given the large gap between now and retirement.

“For Millennials, it’s all about their risk capacity since they have so much time,” says Katherine Roy, chief retirement strategist at J.P. Morgan in New York City. “The volatility they’re experiencing is quite small relative to the value that their contributions are making, so they can take on sufficient risk and benefit from their 30-to-40-year horizon.”

Roy urges the generation to emphasize retirement savings. She points out that while Millennials are often defaulted into a defined contribution (DC) plan when beginning employment, few ever take the initiative to increase contributions during their later years. Instead of contributing the suggested 10% to 15% of pay throughout their career, some settle on the initial 3% to 6%, failing to self-grow the rate, she says. Securing a high savings mentality, Roy adds, is how Millennials can thrive in periods of market uncertainty.  

“When the markets became volatile, if you’re a Millennial, your best point is to be saving enough, because that’s going to be the key to your success, specifically early in your career,” she says. “That is going to have a much more meaningful effect on wealth accumulation for retirement than your return.”

Market volatility can represent buying opportunities for Millennials, as stock prices are lower; however, uninformed employees may feel insecure, usually younger Millennials just beginning their careers, says Tina Wilson, head of investment solutions at MassMutual in Enfield, Connecticut. Even older, more career-experienced Millennials—typically those in their early-to-mid-30s—can experience bouts of financial insecurity during market volatility, she says. Wilson suggests plan sponsors and advisers offer scores of financial health or retirement readiness to DC plan participants. Throughout periods of market swings and downturns, a score represents support for unsure Millennial workers looking to stay on track with their savings. 

“We all in this industry have to recognize that investments are not always a logical component of someone’s thought process, meaning emotions are involved when people invest,” Wilson says. “Having that score is a pretty immediate reinforcement that they’re on track, that they need to stay on track and that having that emotional reaction to investments is not the best strategy for them.”

And, diving deeper into the distinction between younger and older Millennials, Wilson says plan sponsors and advisers should understand the significant financial needs and experiences between both groups. For example, younger Millennials, regarded as those in their mid-to-late 20s, will less likely remember the Great Recession of 2008. Yet, Millennial workers in their 30s will, as most had just entered the workforce 10 years ago, during the market downfall.

“We speak of Millennials as if they are one cohort, and while we label them as one cohort, there is a significant difference between the older Millennials and the younger,” Wilson says. “The younger Millennials know nothing about 2008 and forward. And so for them, it’s been a pretty strong market in their working career. Older Millennials obviously were impacted by 2008, as the rest of us, but they’ve seen a pretty strong recovery.” Plan sponsors and advisers need to look at the different financial needs and experiences to craft education and savings prompts that fit.

Wilson adds, “It comes down to making sure you’re deploying strategies in keeping their future outcome front of mind.”
Administration January 22, 2019

Updating Loan Policies to Discourage Participants from Taking Plan Loans

Changes to maximum loan amounts and number of loans, as well as the imposition of fees and higher interest rates on loans can be written into loan policy statements in an effort to discourage this type of plan leakage.
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Art by Hye Jin Chung
Art by Hye Jin Chung
Art by Hye Jin Chung

While the retirement plan industry is primarily focused on helping participants invest more money, it is equally important to discourage them from taking out loans or hardship withdrawals, says Snezana Zlatar, senior vice president and head of full service product and business management at Prudential Retirement in Woodbridge, New Jersey.

“Dipping into retirement savings early, suspending contributions to defined contribution (DC) plans, or both, can reduce workers’ retirement savings on average by 14%, delaying retirements and costing employers more for salaries and benefits as their workforce ages, according to MassMutual’s analysis,” says Tom Foster, national spokesperson for the firm’s workplace solutions unit in Enfield, Connecticut. And the younger the participant, the greater the impact because of their savings time horizon.

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For example, a 29-year-old who takes out a hardship withdrawal reduces his retirement readiness by an average of 20%, whereas a 60-year-old who takes out the same amount reduces his retirement readiness by only 3%, Foster notes.

Of course, retirement plan sponsors always have the option of barring loans, but that could have the unintended consequence of lowering participation in the plan because employees want to be able to access their money, Foster says. This is undoubtedly why the 2018 PLANSPONSOR Defined Contribution Survey: Plan Benchmarking report found that 79.3% of all plans make loans available.

Unfortunately, “when employees know they have quick and easy access to their 401(k) plans, often, they begin to view their retirement plan as a revolving credit line,” says Amy Ouellette, director of retirement services at Betterment for Business in New York. “That said, every six months an issue could crop up, leading participants to layer one loan on top of another.”

On top of that, with the average job tenure in the U.S. being just over four years and the period to repay a loan being five years, if a participant with a loan should leave their employer before the loan is due, the entire balance is due within 60 days, she adds. If it is not repaid and the participant is under the age of 59-1/2, it is treated as a distribution, she continues. That means the taxes that were withheld on the contributions will be due in addition to a 10% penalty, Ouellette says.

Changing loan policy statements to discourage loans

Thus, there are changes to loan policy statements (LPS) that retirement plan sponsors should consider when making loans available, experts say. While the Department of Labor (DOL) permits loans up to $50,000 or half of the participant’s balance, whichever is lower, sponsors might consider altering their LPS to limit that to $20,000 or $30,000, Foster says.

Sponsors might also want to create a screening process that includes requiring participants to read materials about the adverse consequences of taking out a loan, have them sign that document and make this part of the LPS, he adds. “That might be a way to get participants to rethink taking out a loan.”

The LPS should also permit only one loan at a time and create windows of time between each loan that act as barriers, says Andy Heiges, group manager for advice, retirement income and financial wellness at T. Rowe Price Retirement Plan Services in Baltimore, Maryland. Many retirement plans do not permit participants to contribute to their 401(k) when they are repaying back a loan, which Heiges thinks they should permit.

Sponsors should also consider amending their LPS to permit participants to continue repaying back the loan after being separated from the company, says Chad Parks, founder and chief executive officer of Ubiquity Retirement +  Savings. However, “the plan sponsor and the recordkeeper have to agree on this policy, and the sponsor may not want to be burdened with ensuring that the participant continues to send in their payments proactively, since the money will no longer with automatically withdrawn from their paychecks,” he points out.

Imposing a loan origination and maintenance fee on the loan could also serve as a deterrent, Zlatar says. Related to this is increasing the interest amount that a participant pays, says Marina Edwards, senior director, retirement, at Willis Towers Watson in Chicago. The most common interest rate that sponsors impose on retirement plan loans is one percentage point above the prime rate, Edwards notes. Sponsors may want to amend their plan documents to change that to two percentage points, she says.

“The interest rate must be reasonable, and the IRS has informally stated at conferences that prime plus 2% would be reasonable,” she says. Not only might this act as a deterrent, but because the interest rate goes back to the participant’s account, plan sponsors like this because it ensures that the participant is putting more money into their retirement account, Edwards adds.

Using financial wellness to discourage loan use

Beyond changes to the loan policy statement, it is also very important to provide financial education to employees, particularly about budgeting, says Josh Sailar, investment adviser with Miracle Mile Advisors in Los Angeles.

“Offering a financial wellness program that goes beyond the 401(k) plan on budgeting is important,” Ouellette agrees. That is why Betterment has advice built into its platform, she says.

In line with this, it is important to encourage participants to create an emergency savings fund, Sailar says. Zlatar agrees that this is a vital step sponsors should take to possibly preclude participants from taking out loans, noting that Prudential research found that 63% of Americans could not afford even just a $500 emergency, and 31% would consider retirement plan loans or withdrawals to cover those expenses.

This is why last July, Prudential created a post-tax emergency savings fund feature within its retirement plan platform. In line with this, Sailar says it is important for sponsors to offer other savings vehicles, such as 529 college savings plans and health savings accounts (HSAs).

Finally, sponsors need to be aware that the IRS and DOL often find in their retirement plan audits that sponsors make mistakes with regards to monitoring loans, according to Edwards. For instance, if a participant goes on leave and is still required to make payments to their loan, often the sponsor fails to follow up on that, she says.

“We encourage plan sponsors to work with their recordkeepers to do an independent compliance review of their plan loans,” Edwards says. “They need to check the loan status of their plan to check for such things as whether or not some loans are past five years. That would be a problem.”

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