When President Bush signed the Pension Protection Act in 2006 (PPA), he called it the most sweeping change to pension legislation in 30 years. The bipartisan bill modernized and improved retirement planning options for Americans. When politicians put aside petty differences, constituents benefit.
Humans are creatures of habit. To improve retirement outcomes, behavioral scientists argued for automatic enrollment in 401K plans for new hires with the option to “opt-out.” The PPA encouraged employers to enroll employees automatically, and it worked. Vanguard found that 401K plan participation with new hires is over 90 percent compared to less than 50 percent with voluntary enrollment. Sloth sometimes pays; very few decline auto-enrollment plus they stick with it. After three years significantly more (92 percent) automatically enrolled employees remained with their 401K plan compared with voluntarily enrolled workers (62 percent).
Another feature promoted by the PPA was automatic annual increases of employee contributions. Participants can raise or lower contributions as well as discontinue automatic increases. Vanguard found that after three years over 50 percent of participants continued with automatic escalations. Another 14 percent boosted contributions while maintaining automatic increases.
The PPA’s most profound change was how it altered investment options by encouraging the use of target-date funds (TDFs), investment vehicles designed to coincide with a specific event like college funding or retirement. TDFs are a “set it and forget it” strategy where the investment becomes less risky as retirement or your spending goal approaches. Their use has exploded over the last decade. In 2006 only 32 percent of 401K plans offered target-date funds. Fidelity found that over 98 percent of employers use them today. For workers just beginning to save or decades away from retirement, the beauty of simplicity cannot be overemphasized. In separate studies, Vanguard and Fidelity found a significant number of accounts that outperformed had a single descriptor; the owner had forgotten about them.
A legitimate complaint about TDFs is one size doesn’t fit all. Risk tolerance and goals vary among individuals even with similar retirement dates. As the market grows perhaps more sophisticated options should evolve. For instance, 529 college savings plans offer age-based choices with the owner choosing an aggressive, moderate or conservative design.
As retirement approaches, it is critical to make sure the asset mix is appropriate for your time horizon, and asset mixes can change, too. Understand how the plan intends to reduce risk over time, its glide path. Just because you envision a 2025 retirement doesn’t mean you can’t choose a 2015 or 2035 TDF. Don’t forget the average 2010 TDF lost over 20 percent in 2008. As retirement approaches, a mix of cash, short term bonds or CDs is essential. TDFs aren’t perfect investments — nothing is. Many investment professionals, even those posing as fiduciaries, scorn TDFs but that’s because they can’t justify management fees with TDFs.
You can’t always get what you want but Buz Livingston, CFP can help you figure out what you need. For specific advice, visit livingstonfinancial.net or drop by 2050 West County Highway 30A, M1 Suite 230.