When it comes to retirement savings, most people start too late, don't save enough, and
then fail to protect their savings through a diversified portfolio.
That is expected to start changing this year under a new law signed last August by
President Bush and undergoing final rule-making by the Department of Labor. The
Pension Protection Act of 2006 (PPA) contains three "automatic" provisions designed to
boost participation in defined contribution pension plans, such as 401(k) plans.
The three provisions are auto-enrollment, auto-increases and auto-default. The PPA gives
employers more freedom to automatically enroll employees in 401(k) plans, automatically
increase their contributions, and automatically invest their contributions in funds that
simplify investing and offer more growth potential.
It is well-known that many of America's workers are not saving enough for retirement.
Annual surveys show that just three out of four eligible workers participate in defined
contribution, or DC plans. According to the 2006 Retirement Confidence Survey,
conducted by the Employee Benefits Research Institute, only half of all Americans age 55
or older have saved $50,000 or more for retirement. Worse, according to the Labor
Department, employees do not invest wisely. Their accounts default to conservative
investments such as money market funds that likely will not generate sufficient savings
for a secure retirement.
Employees can't expect their employer to bail them out. Most firms no longer provide a
company pension, also known as a defined benefit, or DB, pension plan. Even among the
big companies, for instance, those that make up the Fortune 500, only about 60 percent
have open pension plans. Some of these are considering "freezing" or phasing out their
DB plans and converting solely to DC plans. Social Security will help, but it won't be
enough. Increasingly, it is falling to individuals and their families to assume chief
responsibility for their financial security.
Just getting started can be a big hurdle for employee participation in DC plans. It is the
familiar tale of the ant and grasshopper. The ant toils during the summer to save food for
the winter. The grasshopper chirps away, oblivious to the impending change. Later, cold
and dying of hunger, he spies the ant handing out corn kernels from his summer stores.
Too late, the fable says, the grasshopper understood "it is best to prepare for the days of
necessity."
The PPA addresses the inertia issue by encouraging companies to automatically enroll
employees into DC plans at a deferral rate that increases annually, up to a maximum of 9
to 9.5 percent depending on company contributions and vesting schedules. An employee
can choose not to participate, but must opt out within 90 days. Withdrawals after 90 days
would carry tax penalties.
The PPA offers a safe harbor for companies to invest the retirement contribution into a
qualified default investment. So instead of allocating monies to conservative, low-yield
investments, employers can choose alternative investments that could generate higher
returns.
The Labor Department is scheduled to announce this year its decision on what it calls
"qualified default investment alternatives," or QDIAs. But basically, they are saying
participants need default vehicles that are simple, diversified and age appropriate. It is
exactly this combination that investment firms and others had in mind in the creation of
what are known as lifecycle funds, or alternatively, target date funds.
These funds feature portfolios that reallocate over time to become more conservative.
That is, they become less heavily weighted in equity investments as participants approach
and pass beyond retirement. Employees are simply placed into the fund with a target
date nearest the year they expect to retire.
For instance, a person who reaches retirement age in 2040 might default to a 2040 fund.
The percentage of equities would begin high, perhaps even at 100 percent, when the
participant was young, but would gradually reduce as the participant aged. At retirement,
some percentage of equities might remain in order to grow the fund to provide some
income through the participant's life expectancy.
The next few months will be interesting as employers begin driving the three "autos" in
order to broaden employee participation in DC plans. But to assure they are not taken for
a ride, employees would do even better to follow the ant's advice, and take personal
responsibility for their own "days of necessity."
The LifePoints® Funds are a series of funds of funds which expose an investor to the risks of hte underlying
funds proportionate to their allocation. Investment in LifePoints funds involves direct expenses of each fund
and indirect expenses of the underlying funds, which together can be higher than those incurred when
investing directly in an underlying fund.
Each of the LifePoints® Funds, Target Date Series, invests its assets in shares of a number of underlying
Russell Investment Company Funds. The allocation of each fund’s assets is based solely on time horizon and
will become more conservative over time until approximately the year indicated in the Fund’s name, at
which time the allocation will remain fixed. From time to time, Russell Investment Management Company
expects to modify the target asset allocation for any fund and/or the underlying funds in which a fund
invests. In addition, the funds may in the future invest in other funds which are not currently underlying
funds.
Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor
an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general
information contained in this publication should not be acted upon without obtaining specific legal, tax, and
investment advice from a licensed professional.
Russell Investment Group is a Washington USA corporation, which operates through subsidiaries worldwide
and is a subsidiary of The Northwestern Mutual Life Insurance Company.