Employee Retirement Plans

We don’t expect doctors treat all patients based solely on age. So why would we develop employee retirement plans that way? How can a target-date solution that invests everyone with the same retirement date in the same portfolio—regardless of risk capacity or retirement readiness—be successful for every employee? The simple answer: For most organizations, it can’t. Each employee has an optimal asset allocation based on that individual’s goals and unique financial situation.

Managed accounts give employees the ability to personalize their account and how it’s invested. They encourage a level of engagement that target-date funds don’t: Personalized communications can contribute to an increase in retirement income and a greater savings rate, arguably the most substantial benefit of managed accounts. According to a study we conducted¹ of people using our advice and managed accounts service, on average 87% of employees increased their savings rates; the average increase of their savings rate was 28%.²

Sometimes aligning an employee’s asset allocation with the average U.S. employee makes sense, but most employees’ financial situations are more complex than that. Even details related to where an employee lives—like state taxes, housing costs, and market volatility—should affect a portfolio.

Think about your own financial situation. What information would say something about you that makes you different from the average U.S. employee? Maybe you live in a state with a higher-than-average income tax rate. Perhaps your company provides a better-than-average 401(k) match, or maybe it doesn’t match your contribution at all. By incorporating this kind of readily available information about employees, employers can apply a personalized approach to retirement planning—helping to identify a clear path for each of their employees to prepare for retirement.

How Does Personalization Affect Allocation
You probably have some things in common with your employees. You live in the same city. Maybe you’re of a similar age. Even if you do share these circumstances, chances are you are significantly different, too. These differences are what contribute to a person’s total risk level and influence that individual’s target asset allocation. While some employees may be like the average U.S. investor and fall into the target-date fund’s path, most won’t. The chart on the previous page shows how allocations for employees can vary when additional information is used.

Average investors are only a small part of the overall group of employees—employees whose allocations fall out of the average may have trouble meeting their retirement goals with options like a target-date fund.

But I’ve heard...
Some employers are hesitant about managed accounts because of the potential costs involved. These costs can vary significantly by provider (including some where the service is included in the base recordkeeping fee.) While fees are paid for by the employee, our research shows that even after paying these fees, on average, employees using managed accounts have the potential to see more income in retirement than those who do not use such a service. Our study found that a 25-year-old employee could have almost 40% more retirement income after using an advice and managed accounts service with an annual fee of 0.40%.³

There’s a misconception that managed accounts act like target-date funds unless each employee takes the time to submit personal information. But a significant level of personalization can happen just with the data that the recordkeeper can provide to you or a third-party service. It’s true that the more individual information provided, the more customized the recommendations will be, so employees are encouraged to provide as much information as possible.

Learn more about managed accounts and how they compare to target-date funds: global.morningstar.com/HelpRetirePSA2

Morningstar^® Retirement Manager^SM is offered by and is the property of Morningstar Associates, LLC, a registered investment advisor and wholly owned subsidiary of Morningstar, Inc., and is intended for citizens or legal residents of the United States or its territories. The Morningstar name and logo are registered marks of Morningstar, Inc.

¹The percentage of participants that increased their savings deferral rates is determined by comparing each participant’s savings deferral rate prior to and after using the Morningstar Retirement Manager service. Participants who increased their savings deferral rate after using Morningstar Retirement Manager are included in this data point.

The average increase in saving deferral rates is determined by analyzing each participant’s savings deferral rate prior to using and after using the Morningstar Retirement Manager service. The result is the average across all participants included in the study.

²This figure represents the potential wealth increase an average 25-year-old could have at retirement when using a managed accounts service versus an average 25-year-old that did not use a managed accounts service.

The analysis is based on 58,444 participants who used the Morningstar Retirement Manager service between the dates of January 2006 and February 2014. Participants are grouped by the age when they first implemented or received advice from Morningstar Retirement Manager and are assumed to have an initial retirement account value of $0 and a retirement age of 65.

The results show that the average participant who first uses Morningstar Retirement Manager as a 25-year-old with a 0.4% annual fee could have 38.9% more retirement income at retirement than an average 25-year-old participant who did not use Morningstar Retirement Manager. Similarly, the average 45-year-old using Morningstar Retirement Manager with a 0.4% annual fee could have 23.3% more and the average 55-year-old could have 13.8% more retirement income at retirement.

The amount of additional retirement income attributed to the use of Morningstar Retirement Manager at retirement varies by age, and tends to decrease with the age the participant first uses the Morningstar Retirement Manager service. Additionally, the potential amount of additional retirement income increases as the management fee decreases; conversely, decreases as the management fee increases.

The average difference in the saving rate before and after using Morningstar Retirement Manager is calculated for each age group. The savings rate was applied to an assumed median income value for each age group. In a similar manner, the average difference in portfolio investment return before and after using Morningstar Retirement Manager was calculated for each age group. Six different annual fee levels (0.0%, 0.2%, 0.4%, 0.6%, 0.8%, and 1.0%) for the Morningstar Retirement Manager advice service were analyzed and the fee was applied to the average portfolio balance for each age group on an annual basis. The final account value for each age group at retirement age was then compared for each annual fee level. This analysis does not account for all portfolio costs such as fees, taxes, or expenses other than the annual account fee. If included, they would lower the potential amount of additional retirement income at retirement shown in this analysis. In no way should the results of this analysis be considered indicative or a guarantee of the future performance of an actual client using Morningstar Retirement Manager or considered indicative of the actual performance achieved by actual participants that have used Morningstar Retirement Manager.

For important information regarding the research statistics, and to download the full study, go to http://corporate.morningstar.com/US/documents/ResearchPapers/Expert_Guidance.pdf

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