Can You Get the Best of DB With the Best of DC?...Can You Get the Best of DB With the Best of DC?...

Speakers:

Toni Brown, CFA, Senior Vice President, Capital Group

John Doyle, Senior Vice President, Capital Group

Can You Get the Best of

DB With the Best of DC? Ideas for “DB-izing” a Defined

Contribution Plan

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or

any other entity, so they may lose value.

Can We Get the Best of DC and the Best of DB?

Employees should be …

• Enrolled

• Saving enough

• Investing appropriately

• Not touching their money until retirement

DB satisfies the above ...

… how to get DC there?

Problem: Unlike DB, the DC System Is Subject to Participant Behavior

1

… But We All Know That’s Not the Case for Many

A Tale of Three (Conflicting) Numbers

55%Percentage of workers

who are at least

somewhat confident that

they have enough money

to live comfortably in

retirement1

44%Percentage of workers

who have tried to

calculate how much

money they need to

save for a comfortable

retirement1

$111,000Median 401(k)/IRA

accumulation of older

working households

(heads of household

ages 55 to 64) in 20132

1EBRI, “The 2014 Retirement Confidence Survey,” March 2014.

2Center for Retirement Research at Boston College, “401(k)/IRA Holdings in 2013: An Update From the SCF,” September 2014

2

It’s Not Just the Participants’ Problem

Delayed retirement can result in:

• Higher health care costs

• Less efficiency

• Reduced productivity

• Stalled career paths for younger workers

There Are Consequences for Plan Sponsors

3

The Planned Retirement Age Has Been Rising

Percentage of Respondents Who Plan to Retire After Age 65

11%

18%21%

31%

36%33%

1991 1999 2004 2009 2013 2014

Survey Year

Source: EBRI, “The 2014 Retirement Confidence Survey,” March 2014.

4

It’s Not Just the Participants’ Problem

There Are Serious Consequences for Plan Sponsors

Employees Who Delay Retirement Tend to Rate Their Plans Poorly

Retire Early No Change Retire Later

All Employees

“Plan meets needs” 34% 45% 19%

“Plan does not meet needs” 10% 27% 60%

Age 50+ Employees

“Plan meets needs” 35% 49% 16%

“Plan does not meet needs” 8% 33% 58%

Source: Towers Watson, “Which Employees Are Delaying Retirement and Why?,” September 25, 2014. Note: Based on full-time

employees enrolled in a retirement plan. 2013/14 Global Benefit Attitudes Survey – U.S.

5

It’s Not Just the Participants’ Problem

“Disengaged workers are 11 percentage points more

likely to delay retirement and 12 percentage points

more likely to expect to retire at older ages. This

reinforces the supposition that many retirement delays

reflect the employee’s need to keep working rather than

his or her strong connection to work or the employer.

Many of these workers simply can’t afford to retire.”

— Towers Watson

There Are Serious Consequences for Plan Sponsors

Source: Towers Watson, “Which Employees Are Delaying Retirement and Why?,” September 25, 2014.

http://www.towerswatson.com/en-US/Insights/Newsletters/Americas/insider/2014/which-employees-are-delaying-retirement-and-why

6

Poll: Can the Existing DC System Lead to

Successful Retirement for Participants?

1. Yes, if implemented to the fullest degree.

2. Maybe, with some tweaks.

3. No, cannot get there from here.

7

Can You Get the Best of DB With the Best of DC?

1. The Pros and Cons of DB and DC Plans

2. What’s Stopping DB-ization?

3. Ideas for DB-izing a DC Plan

Agenda

8

Pros and Cons of DB Plans

Pros

• Investments are pooled and

professionally managed

• Longevity risk is pooled

• Investment risk is pooled

• Full and automatic enrollment

• No participant investment

knowledge needed

• Company bears risk

• Eliminates participant behavior

variables

Company Bears Risk, but Assets Are Not Portable or Liquid

Cons

• Vesting causes real issues (job

changes)

• Not liquid – pro or con?

• Difficult to understand

• Challenging to see value

• Benefit often lacks visibility to

employee

• Unpredictable for company

• Portability – participant can’t

consolidate

9

Pros and Cons of DC Plans

Pros

• Portable

• Liquid

• Benefit is visible to employee

• Company contribution is valued

• Participants have more control

Investments Are Portable (and Liquid) … But Risk Shifts to Participants

Cons

• Participation is voluntary

• Participants often make poor

decisions

• Participant bears risk

• Insufficient savings

• Risks are not pooled

• Employees think they can’t afford

to save

• Employees don’t understand the

money needed in retirement

10

Why DB-ize a DC Plan?

Change Plan Structure to Position More Participants to “Get It Right”

What Have Been the Barriers to DB-ization?

Cost Time Complexity Risk Income DB-ization

11

The Movement to DB-ize DC Plans

Auto-Enrollment and Auto-Escalation Aim to Give a More DB Experience

Changes Since the 2006 Pension Protection Act

DB-Like

Quality Sought

Full participation

Adequate savings rate

Professionally packaged

and managed retirement

portfolio

12

DC Weaknesses

Addressed

Lack of participation

Low savings rate

Inappropriate asset

allocation

DC Change

Auto-enrollment

Auto-escalation

QDIA (e.g., target date)

No auto-enrollment or

auto-escalation, but

considering

Yes, auto-enrollment

with auto-escalation

Yes, auto-enrollment

without auto-escalation

No auto-enrollment or

auto-escalation and not

currently considering

Some Plans Have Yet to Adopt Auto-Enrollment

Auto-Enrollment and Auto-Escalation Are Becoming More Common

Plans Using or Considering Auto-Enrollment or Escalation

26% 18%

26%30%

Source: “Trends in 401(k) Plans and Retirement Rewards: A Report by WorldatWork and the American Benefits Institute,” March 2013

13

Poll: What Does Your Plan Offer?

1. Auto-Enrollment

2. Auto-Escalation

3. Considering one or the other

4. Not considering either auto feature

14

The Problem: 3% Is Not the Solution

Employers Are Setting the Default Contribution Rate Too Low

0% 9% 10%

53%

11% 11% 5%

Less than 1.0% 1.0%–1.99% 2.0%–2.99% 3.0%–3.99% 4.0%–4.99% 5.0%–5.99% 6.0% or greater

0%

97%

3% 0%

Less than 1% 1.0%–1.99% 2.0%–2.99% 3.0% or greater

Initial Default Employee Contribution for Plans Offering Automatic Escalation

Annual Escalation Rate

Source: “Trends in 401(k) Plans and Retirement Rewards: A Report by WorldatWork and the American Benefits Institute,” March 2013

15

Consider Ernie

New Employee — Age 22

Assumptions

Starting age 22

Retirement age 65

Life expectancy 85

Initial investment $0

Starting salary $30,000

Annual salary increase 3.5%

Annual Contribution 3%

Assumes investments during accumulation are made at the beginning of the year. Assumes withdrawals during retirement are

made at the beginning of the year. The successive slides regarding results of this hypothetical scenario assume a 6% rate of

return to retirement and then 4% from retirement until end of life expectancy. This case study is for illustrative purposes only and

is not intended to portray actual investment results. Each investor’s experience may vary.

16

Consider Ernie

Newly Retired — Age 65 (Auto-enrolled at 3%)

Outcome: 10% Salary Replacement Ratio

Annual Contribution 3%

Ending salary at age 65 $132,000

Annual % investment returns 6.5%

Retirement savings at age 65 $343,000

4% annual withdrawal $14,000

Salary replacement 10%

Based on assumptions on slide 16.

Replacement ratio calculated as ending salary at age 65 divided by Ernie’s average annual withdrawals post-retirement.

17

Consider Ernie

Newly Retired — Age 65 (Auto-enrolled at 6%)

Outcome: 21% Salary Replacement Ratio

Annual Contribution 6%

Ending salary at age 65 $132,000

Annual % investment returns 6.5%

Retirement savings at age 65 $686,000

4% annual withdrawal $27,000

Salary replacement 21%

Based on assumptions on slide 16.

Replacement ratio calculated as ending salary at age 65 divided by Ernie’s average annual withdrawals post-retirement.

18

Help Participants Think of DC as an Income

Stream

• Translate account balances to annual income

• The numbers should:

– Be “real”

– Include future contributions and reflect inflation

• An employee who sees that his/her account balance

would only result in 30% replacement ratio may

decide to save more.

Employee Communications Should Project How Long Savings Will Last

19

Drive Participation

• Profit-sharing contributions

• Stretch the match

• “Auto” plan services

• Organizational culture

Use These DB-Like Ideas to Boost Numbers in the Plan

20

Adjust the Culture of the Organization

• Paternalistic approach

• Assume all eligible employees will participate

• Encourage “peer pressure” tactics

Assume a More Paternalistic Approach

21

Priority: Reduce or Eliminate Leakage

Take Steps to Preserve Account Balances

401(k) Loan Activity

Percentage of participants who had loans outstanding at end of period

15.3%16.5%

18.2% 18.5% 18.2% 18.2%

2008 2009 2010 2011 2012 2013 (4Q)

Source: Investment Company Institute Survey of DC Plan Recordkeepers (December 2008–December 2013)

22

Priority: Eliminate or Reduce Leakage

• Loans

• Hardship withdrawals

• Terminations – keep the funds in the plan

• Encourage roll-in for new eligible employees

• Services for past eligible employees and retirees

• Make it harder to get out

Take Steps to Preserve Account Balances

23

Streamline the Number of Investment Options

Research Shows Having Too Many Options Paralyzes Participants

Conservative Aggressive

Risk

Tier IAsset allocation

Tier IICore building blocks

Capital

preservation

Global

bond

Diversified

inflation

Global

equity

Tier IIISpecialized

Self-directed

brokerage window

Target date

funds

Plan is hypothetical and for illustrative purposes only.

24

QDIA

• Balanced

• Target Date

• Managed Accounts

Select and Evaluate Thoughtfully

25

Investment Re-enrollment

Many Participants Do Not Know How to Invest

Plan Sponsor ABC

Data are hypothetical.

26

Investment Re-enrollment

Hypothetical Plan (in millions of dollars)

Beforere-enrollment

Afterre-enrollment

Tier I Assets % of portfolio Assets % of portfolio

American Funds

Target Date Retirement Series®$40 13% $248 82%

Tier II Assets % of portfolio Assets % of portfolio

Vanguard Prime Money Market Fund $50 16% $10 3%

PIMCO Total Return Fund 20 6 4 1

Washington Mutual Investors FundSM

30 10 6 2

Vanguard S&P 500 Index 35 11 7 2

The Growth Fund of America® 45 15 9 3

EuroPacific Growth Fund® 60 20 12 4

CRM SMID Cap 20 6 4 1

Total $300 ~100% $300 ~100%

27

Poll: Has Your Plan Done an Investment

Re-enrollment?

1. Yes.

2. Not yet, but it is scheduled.

3. We are currently discussing this topic.

4. We will put it on the agenda for discussion.

5. No, we are not likely to do this.

28

Summary

• Risk sharing (aggregating) cannot be addressed.

• Other aspects can be addressed:

– Enrollment

– Saving enough

– Professional investment management

– Leakage

DB-izing Your DC Plan

29

Poll: Can the Existing DC System Lead to

Successful Retirement for Participants?

1. Yes, if implemented to the fullest degree.

2. Maybe, with some tweaks.

3. No, cannot get there from here.

30

Next Steps

• Auto-Enroll

– Adopt

– Implement, 6% or more

• Auto-Escalate

– Adopt

– Implement, 3% or more

DB-izing Your DC Plan

• QDIA

– Define

– Evaluate provider thoughtfully

– Conduct investment re-enrollment

– Streamline investment menu

• Affect Corporate Culture

– Encourage roll-ins

– Discourage leakage

– Encourage inactive participants to stay

in plan, especially retirees

31

Investors should carefully consider investment objectives, risks, charges and expenses.

This and other important information is contained in the fund prospectuses and summary

prospectuses, which can be obtained from a financial professional and should be read

carefully before investing.

The statements expressed herein are informed opinions, are as of the date noted, and are

subject to change at any time based on market or other conditions. They reflect the view

of an individual and may not reflect the views of others across the organization. This

information is intended merely to highlight issues and not to be comprehensive or to

provide advice. Permission is given for personal use only. Any reproduction,

modification, distribution, transmission or republication of the information, in part or in

full, is prohibited.

32

Investing outside the United States involves risks such as currency fluctuations, periods of

illiquidity and price volatility, as more fully described in the prospectus. These risks may be

heightened in connection with investments in developing countries. Small-company stocks entail

additional risks, and they can fluctuate in price more than larger company stocks. Lower rated

bonds are subject to greater fluctuations in value and risk of loss of income and principal than

higher rated bonds. The return of principal for bond funds and for funds with significant

underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate,

inflation and credit risks associated with underlying bond holdings. While not directly correlated

to changes in interest rates, the values of inflation-linked bonds generally fluctuate in response

to changes in real interest rates and may experience greater losses than other debt securities

with similar durations.

Investments in mortgage-related securities involve additional risks, such as prepayment risk, as

more fully described in the prospectus. Bond prices and a bond fund’s share price will generally

move in the opposite direction of interest rates.

33

Questions?

34