Investing August 1, 2023

Serving Growth-Asset Needs of Older Participants, Retirees

Incorporating alternative assets into a defined contribution investment lineup is an opportunity to reflect older participants’ desire for growth, experts say.
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Art by Ellen Weinstein

Amid widespread concerns about inflation and the rising cost of living, it is not uncommon for older retirement plan participants, or even retirees, to look at their assets and feel a sense of dread. As individuals near retirement, they may feel a need to use their investments to play “catch-up.”

Defined contribution investment menus often do not reflect the needs of participants who want to see considerable growth in their assets at a later stage of life, as traditional asset classes like target-date funds are designed to become more conservative over time.

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Incorporating alternative assets into an investment menu, while a rarity in defined contribution plans, could potentially allow for significant growth, according to Jeremy Stempien, a principal, portfolio manager at PGIM DC Solutions.

“On the whole, I would say that we don’t think that [investment menus] do a great job of incorporating some of those alternative assets that can really move the needle,” Stempien says. “[Alternative assets] can add on a significant number of years of retirement income.”

A recent Georgetown University Center for Retirement Initiatives report, for example, found that for an individual participating in a DC plan, investing in a mixture of private equity and real assets, done over the course of a career, could result in an additional $2,400 per year in spending power for a retiree with $48,000 per year in retirement income.

Downside Protection Is Key

Stempien says older participants should have a balance of growth assets and protection against some key risks, such as inflation and the volatility of the market. He adds that inflation is more of a “subtle risk” to a person’s retirement savings, because, if all they are doing is drawing down from their portfolio, they have no income to offset inflationary bill increases.

Mercer’s “Top Considerations for Defined Contribution Plans in 2023” report argued that portfolios diversified with real assets historically have weathered inflation and market volatility better and have “highlighted the need for including diversifying asset classes managed in a risk-controlled way.”

While alternatives are not commonly found in DC plans, the authors of the Mercer report said exposure may be offered through TDFs. Stempien says incorporating alternatives into TDFs could produce “the most impact for participants in the defined contribution industry.”

But because of litigation related to alternative assets, as well as a lack of understanding, Stempien explains that there has been little uptake of alternatives among DC plan sponsors. In addition, these more non-traditional asset classes are often more expensive than the traditional asset classes typically offered.

“I think to a plan sponsor, where a lot of the rhetoric in the DC market has been about reducing fees, they see something like that, and it gives them pause in adding [alternatives],” Stempien says.

He argues incorporating some of these non-traditional asset classes into a diversified portfolio could be more cost efficient.

“You don’t want to offer certain asset classes that can end up taking the fee of your portfolio to some really large expense ratio that’s outside of the norm,” Stempien says. “You can balance that by just incorporating some of these asset classes, that at standalone might be more expensive, into a diversified portfolio.”

An argument against using illiquid investments in a DC lineup is that it is difficult for investors to get daily pricing and regularly check their balances. Those assets tend to be harder to sell quickly because there is low trading activity or it takes longer to find qualified investors. Illiquid assets also can have greater price volatility.

But Stempien argues that there are now vehicles in many of these asset classes that are valued daily and provide daily liquidity.

“I think that has been a hurdle historically, and for those solutions that don’t [provide daily pricing], that is something that they need to address,” Stempien says.

Investment Menus Should Reflect Diverse Needs

Carl Gagnon—assistant vice president of global financial well-being and retirement programs at Unum, an insurance company based in Chattanooga, Tennessee—finds that when people reach their 50s and 60s, if they have not saved enough, they try to compensate by being more aggressive with their retirement investments.

“I think people are trying to continue to gain that return on their investments, especially if they have other resources,” Gagnon says. “If they’ve got some partial income and are only drawing down a little bit, they want to be reinvested in any remaining balances.”

At Unum, Gagnon says the firm works with Fidelity Executive Services, which helps provide a variety of 401(k) investments from which participants can pick and choose.

In addition, Unum launched a partnership several years ago with the financial wellness platform Brightside, which provides a one-on-one financial concierge service for employees. Gagnon says the service is available to employees who need advice about their finances and drawing down their assets in retirement, as well as other immediate financial stressors, such as paying off debt or refinancing a home.

“Providing the tools and resources necessary is important so as people transition to different stages in their lives, including decumulation, they have some guidance [and can] go to somebody from a company, or a plan sponsor, that they’ve trusted throughout their career, versus going into the jungle of the retail environment, where they may not have that ERISA oversight and fiduciary protections,” Gagnon says.

Michael Doshier, a senior defined contribution strategist at T. Rowe Price, believes that if participants have done a good job saving before retirement, they tend to “take risk off the table appropriately.”

“If you haven’t done such a good job saving, you need to continue to have that growth in [your investments], because you could be planning for a 30-year retirement,” Doshier says.

He argues that the value created by higher-growth-oriented portfolios usually “far outweighs the short-term market volatility.” Over time, T. Rowe has found that while the percentage drop in more aggressive portfolios can feel shocking for a quarter at a time, the overall value of the underlying account is still greater than more conservative investments.

Doshier adds that it is important for plan sponsors to analyze the demographics of their participants to make sure adding riskier or illiquid assets is worthwhile. Participants in their 50s and 60s have diverse financial needs, depending on their savings history and other factors, and Doshier says plan sponsors should think of retirement income as a “sequence of products” that can apply to various situations.

Opportunity in Managed Accounts

Stempien points out that managed accounts have become a more attractive option for plan sponsors as pricing has come down, and managed accounts are now more competitive with TDFs, to which plans typically default.

Managed accounts can be another vehicle that plans offer to enable participants to incorporate non-traditional asset classes, as they create individualized, managed portfolios.

“These portfolios are built for individuals in an institutional type of offering where you’re getting these solutions for much cheaper than you often could, and it’s put into a portfolio to manage risk,” Stempien says.

The main differentiator between a managed account and a target-date offering, according to Stempien, is the added level of customization. Managed accounts are able to “toggle the risk level up or down” depending on an individual’s unique situation.

Stempien emphasizes that achieving growth also means adding protection on the downside for inflation and market volatility.

“When we are building and modeling our portfolios for retirees, it’s more about saying, ‘Yes, we want to capture some of the upside growth,’ but when we see volatility in the market, we want to make sure that we’re protecting better than what most other solutions do.”

Administration July 21, 2023

Auto-Portability, Step by Step

With recordkeepers accounting for 63% of the defined contribution market already on board, the Portability Services Network is picking up steam. Here’s how it works.
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Art by Gizem Vural

Defined contribution plans’ leakage, especially among participants with smaller balances, has been widely documented. Automatic portability, which Charlotte, North Carolina-based fintech company Retirement Clearinghouse defines as “the routine, standardized and automated movement of an inactive participant’s retirement account from a former employer’s retirement plan to their active account in a new employer’s plan,” has been promoted since 2014 as a potential solution to leakage.

The auto-portability movement has gained momentum recently, culminating in the 2022 formation of the Portability Services Network, owned jointly by RCH and several of the largest U.S. recordkeepers. Spencer Williams, president and CEO of both RCH and the PSN, says the PSN is meant to serve as a utility for the retirement industry. PSN “is not an entity that is seeking profit for itself,” he explains. “We seek to deliver auto-portability to retirement plan participants at the lowest possible cost.”

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RCH provides the PSN with the people and the technology necessary to deliver auto-portability to the market, Williams explains. Participating recordkeepers bring their plan sponsors to the arrangement, and those sponsors bring the participants. Neal Ringquist, RCH’s chief revenue officer, notes that PSN reaches 63% of the defined contribution marketplace, based on the six original PSN owner/members (Alight, Vanguard, Fidelity, TIAA, Empower and Principal).

Coordination Required

Auto-portability sounds simple enough. Plan participants change jobs; PSN tracks them to their new employer and verifies their identities; employees consent to a balance transfer; and the funds from their previous plan are added to their new plan’s balance.

From an operational and legal perspective, auto-portability “wraps around” a mandatory distribution provision, says Ringquist: “In order to do auto-portability on a negative consent basis, you have to both force small balances out of a plan on a negative consent basis, as well as roll those balances into a plan on a negative consent basis.”

These transfers require coordination among recordkeepers and sponsors, plus extensive data processing. Participating recordkeepers must be both sending and receiving recordkeepers. That means a recordkeeper and its plan sponsor-clients agree that terminated participants who are eligible for auto-portability because they meet the mandatory distribution provisions will be forced out of the plan and their data included in PSN’s systemwide queries. Also, each recordkeeper and plan sponsor must also accept roll-ins of new hires’ transferred balances to their plans.

There is a role for positive consent but per the RCH site, “If no affirmative consent is provided, RCH will rely on negative consent to complete the roll in transaction if no participant response to properly delivered auto portability notifications.

Transfers require reciprocity between force-outs and roll-ins at the sponsor level. For instance, a plan might currently retain departing employees’ account balances greater than $1,000 and cash out accounts with less than $1,000. Plans are permitted to involuntarily distribute terminated vested accounts less than $5,000.  If the sponsor wants to include an auto-portability feature to eliminate issuing multiple small checks and the uncashed check problem, it will be able to accept negative consent roll-ins only at less than $1,000.

Ringquist explains that every roll-in comes through an RCH IRA, either a safe harbor IRA or a conduit IRA. While more than 95% of plans allow roll-ins from other plans, only about two-thirds allow roll-ins from IRAs, he notes, citing Plan Sponsor Council of America data. Plans that do not currently allow roll-ins from IRAs and want auto-portability will need to modify their plan documents to accept IRA roll-ins. Plan sponsors will not have any technology build-outs to adopt auto-portability, but they will need to add a data-sharing provision to their recordkeeper contracts.

Moving Data

From a high-level perspective, RCH describes auto-portability as “an electronic records matching technology that is used to locate and match participant accounts across recordkeeping platforms.” A set of 14 application programming interfaces, known as APIs, are an essential part of automating the locate-and-match technology. These APIs allow recordkeepers and PSN to automatically exchange the data required to search for participants who left their previous plan and subsequently enrolled in a new plan (assuming both plans are with a PSN recordkeeper).

The APIs are also used to enter requests to bring additional companies and plans into the network; to share eligible accounts; to locate and match active accounts; to request and share account details when a participant is located as active in a new plan; to inform of a known bad address or opt-out elections; and to initiate and confirm rollovers into a new plan, according to Steve Holman, head of Vanguard’s Distribution Enablement Group.

The process starts when a participant qualifies to be forced out of his or her previous plan. At that time, the plan’s recordkeeper automatically sends the participant’s Social Security number and account number to PSN. It then replaces the account number with a randomly generated number in a new data set, says Ringquist. PSN then uses its Locate API and sends that data set to its member recordkeepers, who query their databases of plans signed up for auto-portability, seeking the participant’s Social Security number at the new plan.

When an individual is located by Social Security number, the recordkeeper uses the PSN Match API and sends PSN a data set in which they drop the participant’s Social Security number and add certain demographic data to the previously generated random number. PSN goes back to the sending recordkeeper and asks for the same data set. PSN runs the two data sets through a match algorithm to verify the individual’s identity; the entire process is completed by API calls. “To the extent that that account detail is matched above a particular score, that starts the consent process, and PSN sends consent notifications to the individual as we’re operating right now under Department of Labor guidance,” says Ringquist.

Implementation timeline for recordkeepers

The recordkeepers that recently joined PSN have distinct timeframes for introducing auto-portability to their plan sponsors. Ringquist says the implementation consists of three steps.

First, the recordkeeper defines its business requirements for auto-portability. The second step consists of building the APIs. The final step is to test the process. Testing is extensive, because queries can involve millions of records being queried across the recordkeeper’s book of business, Ringquest emphasizes: “I’d say this is a six-month effort when you look at those three phases to get something like this completed from a recordkeeper’s perspective.”

Holman says Vanguard plans to go live with auto-portability on October 1. So far, sponsors’ initial reactions have been universally positive, he says. “They see the value to the participants, and they see the ease of joining the network,” Holman explains. [But] “we’ve only been able to share with them in concept, so they want to see the legal contract that they’re signing to join. We’ll be ready to share that information with the plan sponsors very shortly.”

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