Administration October 27, 2020

Retirement Planning Needs of Private- and Public-Sector Employees More Similar Than Different

Yes, public employees are more likely to have pensions, but some do not get Social Security, and health care costs are increasing for everyone.
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There has been a general perception in this country that public-sector, or government, employees have more generous retirement benefits than employees in the private sector and, thus, do not face the savings and planning needs private-sector employees do.

However, Mike Sanders, principal at Cammack Retirement Group, says there are many similarities in retirement planning needs for private-sector and public-sector employees. Still, there are some differences his firm focuses on when dealing with the two types of plans.

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When the firm is working with a public plan sponsor, such as a city or state, it emphasizes that retirement planning should consider the differences in jobs, Sanders says. “For example, first responders tend to retire much earlier than other public-sector employees or those in the private sector. On average, they retire around age 55,” he says. “They need education about early retirement and possibly having a second career. They should be prepared for more time without the same level of income coming in. They need to save more and invest better because of the additional risk.”

Sanders says public employees tend to have a much longer tenure with employers than private-sector employees, and that allows public plan sponsors to gather better data about all sources of savings and compensation trends. Public employees are more likely to have access to a defined benefit (DB) plan, but he warns that public DB plans have been going through changes. “Some are starting to move to a hybrid plan. We’ve helped launch two of those with large public employers over the past two years,” he says. “New employees are not getting the same benefits they have in mind from what their parent public employee had.”

It’s important to show public employees how to supplement their DB plans. “Higher education 403(b) programs in which employees get 10% to 12% of their compensation put in a year is the closest thing to having a public DB plan,” Sanders notes.

In states where public-sector employees have a DB plan and get Social Security, they might only need to replace about 4% more of their income in retirement, so plans such as 403(b)s and 457s are truly supplemental, Sanders says. However, not all public employees get Social Security.

“You have to look at every employer’s benefits and determine employee planning needs. It’s different for each group,” he says.

From a knowledge standpoint, public employees have a very similar base, Sanders says. The exception, he says, is police and firefighters; “I find they have a very high financial acumen.” But, overall, public employees need to understand basic finance and why retirement is important, he says.

In the private sector, where the majority of companies do not offer a DB plan, there have been discussions for years about adding lifetime income options or annuities into defined contribution (DC) plans, so, upon retirement, participants can annuitize and get a DB-like income stream, Sanders notes. “Annuities often can deliver fantastic results,” he says.

“Still, there is a large proponent of people who, if not properly educated, will go into retirement and look at an annuity and look at the large amount saved and make a poor decision,” he continues. This is why working with a financial adviser would be helpful. However, Sanders says, many workers might not feel comfortable or even know how to reach out to an adviser.

“We still don’t know how to overcome people being uncomfortable with handing a large amount of assets over to an annuity provider,” Sanders says. “But that’s the next thing to happen for our industry.”

Consider Health Care Costs

Health expenses should also be considered in retirement planning, Sanders suggests, no matter if a retiree is a public-sector or a private-sector employee.

“Even if a person gets retiree health benefits, it’s important for them to know the costs and what benefits they are getting,” he says. “More education about costs is needed for private-sector employees. And, some studies say, those who are healthy will have more health expenses in retirement because they’ll live longer.”

The things people don’t think about or don’t talk about ultimately results in hidden costs, Sanders says.

There has been a long trend of retiree health benefits going away in the private sector, says John Barkett, senior director of policy affairs at Willis Towers Watson. “It’s stabilizing now. Around 25% of private-sector companies still offer retiree health benefits, but, 30 years ago, 50% to 65% were,” he says. “In general, public-sector employers continue to provide retiree health benefits at a higher rate than in the private sector—between 60% and 80% do.”

However, Barkett says, while public-sector benefits in general are stickier, there are factors that could be creating conditions that might change retiree health benefits. “Combined with GASB [Government Accounting Standards Board] rules for more transparency about other post-employment benefits [OPEBs], there are a couple of things that could drive employers to look for new options—the threat of declining financial health of employers or governments and the threat of lawsuits if benefits are changed,” he explains.

And public employees aren’t the only ones who might see retiree health benefit changes. Some courts have ruled that health benefits private-sector employees thought were for life are not, Barkett says. Add that potential change to the cost of health care getting more expensive, and it shows all employees need to plan for health care costs in retirement.

“I start discussions with employees reminding them what the costs are,” Barkett says. “Medicare is not as generous as people think and it does have premiums.” He explains that even with Medicare, individuals are still on the hook for about 20% of costs unless they buy supplemental insurance. “They get no drug coverage without purchasing a separate drug plan, and the Part B premium is around $120 to $140 a month. So, they’re looking at $1,300 a year in Part B premiums, and potentially more costs if buy they buy a supplemental plan,” Barkett notes. “With Medicare premiums, individuals are looking at $5,000 a year before any cost sharing. That’s a huge chunk of a retiree’s budget, so planning for this is important.”

Barkett says using a health savings account (HSA) is a good idea for both private- and public-sector employees. “It really makes sense to try to save for health costs in retirement using those accounts because of their triple tax advantage. It’s the most tax-efficient vehicle for saving for retirement,” he says. “The challenge people have is they might need their HSA accounts to pay for care in the present. Or do they have enough money to put into an HSA? Not everyone’s situation is the same.”

If an employee does have a retiree health benefit, he might need to save less; however, Barkett says planning needs are still the same. “Health costs continue to increase, and public-sector employers have changed how they offer health benefits to retirees,” he says. “Anyone relying on retiree health benefits to cover costs hopes they can rely on it, but they should be prepared. Some public employers have capped how much they contribute to premiums or have implemented different eligibility requirements. The fact that those changes have been made implies similar changes can happen in the future.”

Barkett adds that employees should remember there will be health care costs that aren’t included in retiree benefits—such as hearing aids, for example. So it is still a good idea to save for such items.

Having savings in an HSA is valuable if retiree benefits don’t cover everything or if they change. Barkett notes that once an HSA-holder reaches age 65, he can use the money in the account for non-medical related items, and it is taxed as ordinary income. “So, if retiree health care covers health costs and you have to use your HSA for other things, that’s not the worst situation to be in,” he says.

Sanders says public and private employees differ when it comes to the adoption of technology, such as mobile applications—which could be helpful for retirement expense calculations and planning.

“There’s more adoption in the private sector than in the public sector. It comes from long tenures in employment. Public sector employees may not have gone through job changes and had to adapt to technology for benefits enrollment and education,” he says. “However, tech use may become more aligned because of COVID-19.”

Compliance October 22, 2020

The DOL’s ESG Proposal and DB Plans

Defined benefit plan fiduciaries can expand on their evaluations of ESG investments to show they are financially beneficial and not just a philosophical choice.
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There’s a lot of money in corporate defined benefit (DB) plans, and it can make a difference how those assets are invested.

Cooper Abbott, president and chairman of Carillon Tower Advisers, notes that the Department of Labor (DOL) oversees employee benefit plans that represent approximately $10 trillion in combined assets under the Employee Retirement Income Security Act (ERISA).  Of this total, about $8 trillion is in mutual and other funds, and about $2 trillion is in directly held equities (i.e., equities not in funds). “There’s a lot of power in what investments are saying,” he says.

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This summer, the DOL proposed a rule that addresses environmental, social and governance (ESG) investing in retirement plans. Abbott says the proposed rule is specific that plan sponsors should not invest in ESG vehicles for which the strategy subordinates returns or increases risks for nonpecuniary objectives. Regulators and industry stakeholder have expressed concerns that plan sponsors invest in ESG funds based on fiduciaries’ or plan participants’ philosophies, rather than based on financial factors.

“I think most DB plan trustees are looking at financial factors,” Abbott says. He notes that a divestment approach that the industry used to call SRI (socially responsible investing) is a different approach than an integrated ESG worldview. “An integrated approach says no asset class out there is not fair game. If an investor wants to engage with energy companies, it can use assets to be owners and help companies make improvements,” Abbott says. “Divestment is more of a philosophical approach where the investor is on the outside looking in. I don’t think using ESG is.”

Carillon commented on the proposed rule and said the DOL is limiting how much of a “voice” investors have. “We do not see ESG considerations and returns as mutually exclusive. Secondly, in general, more choice is better for investors,” Abbott says.

He notes that Carillon’s managers have been involved in considering ESG issues for a long time. One thing that has changed in that time is that there is now better data about ESG investments. “ESG investing is a practical approach,” he says. “Understanding whether a company is polluting or whether it treats employees well aligns the interests of shareholders with business management,” Abbott says. “I don’t think these ideas are controversial or new.”

Simon Robinson, director of product management at Moody’s Analytics, says the DOL’s proposed rule about ESG investing in retirement plans is just a clarification and broader calling out of ESG funds for the existing requirement to look at investments for pecuniary benefits. “A retirement plan fiduciary should make decisions on the basis of investment characteristics and whether investments will generate good returns for the retirement plan,” he says.

DB plan fiduciaries will need to look at ESG-related funds closely, specifically when it comes to the potential for generating good returns, Robinson adds. They should be careful about how they evaluate ESG funds and the advice they get about them.

However, he says there are reasons why ESG issues are a financial factor. Asset managers can make good arguments that addressing climate change would have a beneficial impact on asset returns. So a retirement plan fiduciary should be putting ESG investments under more scrutiny to show what is driving returns and the financial impact ESG factors are expected to have.

“One thing we’re interested in looking at is performance attribution, and hopefully it shows how outperformance plays out with respect to ESG factors,” Robinson says. “It might be a way for plans to investigate their funds.

“Looking at ‘E,’ ‘S’ and ‘G,’ plan fiduciaries can construct arguments, and provide evidence as well, that companies with good governance, for example, will perform better,” he continues. “I don’t think the DOL proposal silences plans in terms of how they ‘speak’ with investments. ESG can be a factor in the context of generating strong long-term returns.”

Abbott similarly says ESG is well-suited to research-based views. “There is no black and white about these things. How consumers think about a company has to do with how it looks compared to competitors and how the company is changing over time, which affects its bottom line,” Abbott says.

“Looking at returns generated by an investment in the past and the ability of the investment team to generate returns in the future, if plan sponsors believe an ESG investment can help reduce risk, there is a value to that,” Abbott says. “Also, participating in an industry that is changing and has headwinds, that’s a positive. With more choice, a plan sponsor can align its investment strategy to deliver outperformance and mitigate volatility.”

In the ESG proposal, the DOL says it wants plan sponsors to make clear why they are investing in a given manager or a given strategy, Abbott notes. He says this is what plan fiduciaries do whether an investment is ESG-related or not. “I don’t think there will be a lot of change if the ESG proposal is finalized, because many plan sponsors already have good processes” for selecting and monitoring investments, Abbott says. “From a ‘big picture’ view, the DOL is saying, ‘Not all ESG is good, so be careful.’”

If a DB plan sponsor can’t show a beneficial impact on asset returns, it should look at the performance and future expectations for any given investment, Robinson says. “So, in general, if an investment is not performing as expected, plan sponsors should be considering whether to use it or not,” he says. “The challenge is if the plan sponsor has previously taken a strong view that it wants to hold the strategy for ESG reasons but it’s poorly performing. I would come back to the broad rule, so I would likely get rid of or replace it.”

Robinson notes that ESG factors are often suited for long-term investing, so, for DB plans, ESG investments might conflict with short-term investing strategies.

He recommends that plan sponsors talk to their ERISA attorneys about how to best interpret the DOL proposal. “The DOL doesn’t get into specifics about how to determine financial pecuniary benefits, so plan sponsors need advice about that,” Robinson says. He adds that there is “no magic way” to determine whether an investment is financially attractive or not—looking at past performance is the most concrete way, and forward looking is equally critical.

A Note About the DOL Proxy Voting Proposal

The DOL also recently proposed a rule about proxy voting by employee benefit plans, which applies to the direct investments of employee benefit plans, Abbott says. “The DOL says it wants to reduce plan expenses, and that it wants plan fiduciaries to refrain from voting when the proposal for which shareholders are voting is not going to have a financial impact on the plan,” he says. “But, equity is ownership and ownership has power. Proxy voting is a right of ownership. It seems to me that by the time fiduciaries have done the research to see if a proxy proposal will have a financial impact, they’ve already spent the money the DOL says it wants to save. So, I’m not clear what the proxy proposal is trying to do.”

As for the proxy voting proposal, he says, there could be more guidance about what type of issue matters and warrants research.

A Difference in Government Views

Back to the subject of the DOL ESG proposal, Robinson points out that there is a difference in the landscapes for ESG investing in the U.S. and the UK. In the UK, there is a similar proposal from the Department for Work and Pensions (DWP). However, the DWP proposal that is out for consultation suggests that large pensions report on ESG factors in financial disclosures. “It’s not trying to influence how pensions invest; it’s just a proposal on reporting,” Robinson says.

“In the UK, the government says ESG is good and plan sponsors should consider them, and here’s what to consider specifically,” Abbott says.

He adds that he believes interest in ESG investing will continue to grow, that views similar to those of  the UK government will take hold and that there will be more demand for ESG investing by retirement plan participants. Abbott says this can be good for competition and evolution in the marketplace, and he believes managers will continue their efforts to provide good ESG investment opportunities.

Whether the DOL proposal moves forward in its current form or not, having a more tangible process to address ESG factors in investment selection would be beneficial to plan sponsors, Robinson says.

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