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RETIREMENT INSIGHTS

Will the SECURE Act live up to its name?

Jun 17, 2019
By BlackRock

The goal of the SECURE Act, a bi-partisan bill making its way through Congress, is to offer several measures to help improve retirement security for millions of Americans. To help explain what the bill encompasses for both retirement in general and participants in defined contribution (DC) plans, we spoke to Joe Craven, the head of retirement policy for BlackRock’s Global Public Policy Group, and Dagmar Nikles, head of plan strategy for BlackRock’s Retirement Group.

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What the SECURE Act means
for retirement

Joe Craven’s career has included senior leadership roles in defined contribution, defined benefit and wealth advisory, giving him an ideal background for his role with BlackRock’s Global Public Policy Group. His job is to interact with Congress, congressional staff, regulators and thought leaders on everything related to retirement, regardless of whether BlackRock has a commercial interest.

“It’s really what Larry talks about,” Joe says, referring to BlackRock CEO Larry Fink’s numerous public statements about retirement as an urgent social issue. “Improving retirement security globally is part of our purpose as a firm.”

That’s why Joe’s purview extends beyond defined contribution, private and public pensions and other components commonly thought of as the retirement system. He also advocates on behalf of extending the system to reach millions of people currently without access to a workplace plan, as well as how to address the critical lack of emergency savings that threatens the security of many families.

Joe spoke to us about the SECURE Act to give us insight into how the legislation, if passed, may help improve retirement security.

How can public policy be used to improve retirement security?

Joe Craven: There are a number of policy levers, including tax incentives, behavioral finance tools such as auto-enrollment, and education and disclosure. Mandates are another powerful tool. The most obvious mandate is social security. But, there is discussion of a mandate that employers with more than a certain number of employees be required to offer some form of retirement plan.

That’s a core issue. Over a third of Americans don’t have access to a public or private employer-sponsored plan, and that number is even higher for individuals who work for small businesses.1 There’s a big swath of Americans who only have access to Social Security to support their retirement. From a policy point of view, we want to encourage more people to direct more savings toward retirement. We want to help them get started early, invest in the capital markets long term, keep them invested and give them the ability to have a stream of retirement income.

Does the proposed SECURE Act address these issues directly?

Joe Craven: Yes, it addresses several areas. Two of the most important are access and lifetime income. Through the use of open multiple employer plans (MEPs) and targeted tax credits, the legislation seeks to provide more access to small business employees. In addition, it provides safe harbor protection for lifetime income in DC plans.

Assets in and of themselves don’t do you any good in retirement. You need to be able to convert savings into a stream of income that takes longevity risk off the table. Plan sponsors understand this.

But picking annuity providers is not the same as picking an investment. If a target date fund or another investment underperforms, you can replace it. Choosing an annuity provider is a fifty-year decision and it’s very difficult under current ERISA rules. Plan sponsors are concerned they may be responsible for the claims paying ability of an annuity provider decades from now. SECURE doesn’t absolve them of their fiduciary obligation, but it does provide guidance that if you follow certain criteria when selecting an annuity provider, you will have safe harbor protection in place.

Why is embedding income into a plan important?

Joe Craven: We’ve seen how powerful behavioral finance has been for workplace plans. Auto-enrollment, auto-escalation and what I like to call auto-diversification – which is automatic investment in a diversified target date fund or managed account – have improved people’s savings rates and investment decision making. Right now, 75% of flows into workplace plans are projected to go into target date funds.2 Embedding a guaranteed income option into a target date can use behavioral finance to help address longevity risk.

Is the lifetime income statement provision also a behavioral finance tool?

Joe Craven: Overcoming the resistance people have to guaranteed income solutions is still difficult. Part of it is that when they finally do look at annuitizing, they have what I call a “holy (blank)” moment. Let's say a 65-year old has worked hard and saved and done the right things, and they are proud that they have been able to save $200,000, which is a lot of money. Then they see that it may provide a little more than $8,400 a year.3

Mandating that statements provide an income conversion for current savings retrains participants to think about retirement income. It gives them the information they need while there is still time to take action steps, such as increasing savings or working longer. It is worth noting that SECURE eliminates the maximum age for IRA contributions and pushes out the required minimum distribution age to 72 ½, which makes sense for people who choose to work longer to build up their retirement savings.

While we have advocated for a more product agnostic approach for translating assets into income, we firmly believe the proposed lifetime income disclosure will be a meaningful step that helps people understand retirement more clearly. 

What are the highlights of the provisions around MEPs?

Joe Craven: Open MEPs allow multiple employers to join a single plan, thereby bringing many of the benefits of large plans to smaller employers, such as lower fees and more offerings. The legislation addresses two key issues that have prevented broad scale adoption of open MEPs and we believe it will provide greater access to retirement savings for small businesses and their employees.

It also removes what’s called the “bad apple” rule where a tax violation by one member exposes the whole plan. The new provision would isolate the error and the consequences to the violator.

What the SECURE Act means
for participants

The objective of the SECURE Act is clear in its name: to help bring retirement security to an increasing number of Americans. At least part of its success will depend on individual plan sponsors adopting the improvements the legislation offers. To help us understand the potential impact on workplace retirement plans, we spoke to Dagmar Nikles, head of plan strategy and tools for BlackRock’s Retirement Group.

Through her research, Dagmar notes that several of the proposed SECURE Act features may drive positive change for defined contribution participants. “Our plan design analysis uses participant level data to measure the effectiveness of current plan features and test the potential effectiveness of proposed changes,” she explains. “Our goal is to give plan sponsors empirical insight to help them manage their plans.”

What has you particularly excited about the SECURE Act?

Dagmar Nikles: Let me start with the idea that regulators are clearly responding to evidence and ideas developed in the retirement plan marketplace. It’s reminiscent of the Pension Protection Act in 2006, which gave legislative sanction to plan features like auto-enrollment and target date funds that many plan sponsors began using in the years prior. Clearly, fiduciary safe harbor for the selection of a lifetime income provider in conjunction with lifetime income disclosure and portability of lifetime income options are significant steps forward, but so are seemingly minor provisions such as increasing the cap for auto-escalation.

Let’s start with increasing the auto-escalation cap to 15%. Why is that important?

Dagmar Nikles: There are two primary reasons. The first is that the legislation gives plan sponsors additional flexibility to encourage savings. People are not saving enough. Now we understand saving is very difficult for many people, and many will not be able to save 15% of their salary. That said, it’s clear that saving more can have a significant positive impact on retirement.

The illustration below shows the difference in savings between a 6% savings rate and auto-escalating to 10% or 15%. It’s worth noting that it may take working and saving for an extra five to seven years to reach an equivalent balance without auto-escalation.

Auto-escalation scenarios*

Auto Escalation Scenarios

*Based on BlackRock’s Future in Focus® tool. Please see the Appendix for more information about the inputs used and for the tool’s assumptions and methodology. The projections or other information generated by the Future in Focus App (“App”) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Actual participant outcomes may vary with each use and over time.
^1^Rounded mean income of the 15-24 age group U.S. Census Bureau, Current Population Survey, 2016 Annual Social and Economic Supplement
For illustrative purposes only

What’s the second reason for lifting the auto-escalation ceiling?

Dagmar Nikles: It’s a very subtle effect but setting savings rates and auto-escalation too low may inhibit savings. We recently did a plan design analysis comparing participants who actively selected their savings rate against those who accepted the plan defaults.

In this case, auto-escalation was capped at 6% because the plan was concerned that participants would opt out of anything higher. What we found is that 43% of participants who made some active savings or investment decision (“active”) save more than 6% of their salary, while only 19% of the more inert (“passive”) participants saved more than 6%.

Active participants save substantially more

Active participants save substantially more

For illustrative purposes only

This suggests several things. First, participants who accept the auto-deferral rates tend to stay within them. That is perhaps not surprising. The second is that within this plan, the higher deferrals of the active participants suggests that there is a higher appetite for savings than the plan sponsor assumed. We find it likely that if the auto-escalation ceiling was higher, the great majority of participants would accept higher savings rates.

What about the proposed safe harbor protection for lifetime income within a DC plan? Do you believe participants will take advantage?

Dagmar Nikles: They should at least strongly consider it. Investment professionals know the difficulty individuals face in turning their savings into lifetime income. In addition to market risk, they simply have no reliable way of estimating how long they will need income. The risk of spending their savings too quickly is real, as is the risk of being too cautious and not enjoying their savings as much as possible.

Participants should consider their overall retirement income picture. Most will likely have a combination of social security payments plus whatever they expect to draw down from their savings. They should think of this as certain income and variable income. We say variable because, depending on how one takes income, it may change year over year due to market conditions, either because the return is reduced, or the individual spends less one year to make up for a down year. It can also be variable in that there is great uncertainty about making it last throughout their retirement.

Let’s say they convert 30% of their savings into a guaranteed income stream, however. They can increase their foundation of secure, consistent income year over year, while still having the flexibility to make decisions about how they invest and draw down the rest of their savings.

Potential future paycheck

Potential future paycheck

Safe harbor sounds like a significant step toward guaranteed income, but isn’t there a significant investor bias against guaranteed income?

Dagmar Nikles: We know there are many behavioral hurdles with guaranteed income, but we believe there are steps plan sponsors can take to help overcome them.

For instance, one of the provisions of the SECURE Act requires that participant statements show a lifetime income equivalent for their current savings balance. Over time, that may condition participants to stop thinking about their savings as a lump sum and begin to think of retirement planning in terms of income streams.

Also, embedding guaranteed income into a target date fund with a portion of the portfolio converted to an income stream at the target date may help mitigate behavioral issues around the timing of the purchase and the portion of the portfolio to convert to income.

It may be that there will be less resistance to guaranteed income than in the past, at least for the next generation of retirees. The cohort currently under the age of 40 or 45 has seen the tech bubble and the financial crisis early in their savings career. They may have a different attitude towards risk than baby boomers who lived and invested through the bull market of the 90s.

Joseph Craven
Managing Director and Head of Retirement Policy for the Global Public Policy Group.
Dagmar Nikles
Managing Director and Head of Plan Strategy for the Retirement Group.