Many retirement plan sponsors are increasingly recognizing the benefits of allowing retired employees to leave assets in the defined contribution (DC) plan. This arrangement can be a win-win for both plan sponsors and participants. Fat retiree balances may improve plan economics, allowing plan sponsors to negotiate lower fees. For the participant, it allows them to take advantage of funds that are overseen by fiduciaries, often available at lower costs.
Those passively enrolled generally have their contributions invested by default in the plan’s qualified default investment alternative (QDIA). In light of this, plan sponsors and their advisors may ask: The plan’s QDIA may be appropriate for younger workers, but is it the best choice for retired participants? For that matter, what about near-retirees and other participants who may have different risk profiles?
There are a number of individual investment types to consider to help support the needs of participants, both near retirement and already retired. For example, plan sponsors may want to consider adding risk-managed, multi-asset allocation funds designed to deliver both growth and income as a starting point. It could be supplemented with a fixed income fund to support the more immediate financial needs of retirees and for more risk-averse investors. Retirees with higher risk profiles — those who don’t need to tap their assets immediately — may want more access to equities, perhaps in specialized areas like small-cap and emerging market funds, to help infuse more diversity into the growth portion of their portfolios that won’t be tapped until later in retirement.
While target-date funds are designed to be all-in investments, their one-size-fits-all approach may simply not work for different circumstances. An Aon Hewitt study, which found that slightly less than half (49.7 percent) of investors were using target-date funds “correctly” as their sole retirement investment, suggests some retirement investors may have valid reasons for partial target date use.
For example, the study noted, two 50-year-old participants may have different financial circumstances. One might have a defined benefit (DB) plan, a child who has completed college, and a house that’s paid off. The other might not be eligible for a DB plan, has children just starting college, and has significant mortgage payments. These two participants may need different retirement portfolios, but a target-date fund would treat them in identical fashion. With that in mind, it may not be surprising that as participants age there’s a decrease in the percentage of those using target date funds for their full portfolio, as shown in the chart below.
Asking the Right Questions
To stay ahead of the trends, plan sponsors should work with their advisor by analyzing their pre-retiree and retiree populations now to answer these questions:
- When will most retirees across the population likely need to tap their plan assets?
- Do the current QDIAs meet those needs?
- Should new retiree-focused investments be designated?
- Does the fund lineup need to be expanded to meet the diverse needs of retirees?
- What is the plan’s approach to educating near-retirees on this issue, and possibly tying it to other financial wellness efforts?
- Does the plan allow partial withdrawals?
For more information on QDIAs, contact the advisors at MFA Asset Management today.
Aon Hewitt, Target-Date Funds: Who is Using Them and How Are They Being Used? November 2016.
This is an excerpt of Macquarie Investment Management’s article, “When participants retire, should their QDIA retire as well?”