PLANSPONSOR - December/January 2020 - 44

EXECUTIVE SUMMARY
Low Interest Rates-
The Downside
How the current environment could hurt participants
T
he current period of ongoing low interest rates is generally
seen to have been good for the U.S. economy and has been
accompanied by low unemployment and decent overall
growth. However, a prolonged low interest rate environment has
the potential to affect defined contribution (DC) retirement plan
participant behavior in both saving for and spending in retirement.
Plan sponsors should be aware of this potential and may
want to examine where participant money is going and if any
participant communications or even plan changes are necessary.
In general, about 10% of 401(k) plan assets are in the stable
value offering, according to the Alight Solutions 401(k) Index.
Most likely, investors in this option are near-retirees and conservative
investors. Because rates are and have been low for an
extended period of time, participants seeking better returns may
move to riskier options. In fact, the Callan DC Index found that,
as of this past June 30, equity exposure had continued to rise.
The current allocation to equity options in DC plans exceeded
the Callan Index's historical average by 2.2%. Moving to equities
may not be the right choice for near-retirees who need some
type of capital preservation. Perhaps an outreach to this group
describing the pros and cons of being in a stable value fund at
this point in their career could be helpful.
It may also be helpful to know how stable value investments
react when rates do start to rise. In a typical, moderately
rising rate environment, stable value funds lag current yields so
they will move up more slowly than, say, a money market fund.
However, over time, they typically provide a higher return than
a money market fund and look to supply a consistent stream of
returns, according to the Stable Value Investment Association
(SVIA). Also, the participant's invested capital is preserved.
Another fixed-income option that can be affected by low
rates is a bond fund. However, when participants are buying into
it during a low interest rate environment and rates start to rise,
they may not understand the market risk they face. When rates
rise, these funds will experience lower and potentially even negative
returns. A sponsor may want to proactively communicate
this to participants before rates actually rise, to warn them that
market fluctuations are part of the funds' return.
Some plans offer immediate annuities to participants
who are retiring. Generally, this offering provides institutional
pricing, which is a nice benefit. However, these annuities will
be issued at a spot rate-i.e., the current rate, which today is
44 PLANSPONSOR.COM December 2019 - January 2020
low-which makes the pricing of the annuity more expensive.
It also, of course, provides less monthly income to the participant
throughout his retirement. Sponsors may want to decide if
communication about that option is necessary and if additional
decumulation options should be offered.
In fact, it is more critical than ever that participants plan
well for their retirement and understand that a lower interest
rate environment can lead to less income in retirement, and
therefore less spending. The concept of a retirement tier has
been discussed lately in the Defined Contribution Institutional
Investment Association (DCIIA)'s " Design Matters: The
Retirement Tier " series of white papers. The tier potentially
includes not only an array of decumulation products but also
planning services to engage participants near, at or during retirement.
A sponsor doesn't need to implement all aspects of the
retirement tier at once. It can start by simply examining its plan
provisions to determine whether participants are provided with
different distribution options at retirement.
A prime example is whether the plan allows for partial withdrawals
at retirement vs. a lump-sum distribution only, which is
the case with many DC plans. Allowing for partial withdrawals
lets the participant keep a selected portion of his balance in institutionally
priced investment options, which may help to prevent
the erosion of his savings from retail fees. It also allows the
person to continue to access his employer's planning options so
he can make informed changes as the economic environment
and/or his spending needs change.
Of course, another effect of a low interest rate environment
is that participants may want to work longer. They may want or
need to wait to retire until they can accumulate more savings or
until the economic environment changes. This may give rise to
other sponsor considerations such as the associated expense and
the effect on younger workers, or, on the positive side, the potential
to retain " institutional knowledge " and expertise.
Investing in a low rate environment can be confusing and
challenging for anyone. By communicating the risks noted and
considering plan changes, sponsors can help improve retirement
outcomes over the long term for their participants.
Marianne Sullivan is vice president of committees and
projects for the Defined Contribution Institutional Investment
Association (DCIIA).
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