1. Retirement Plans and Mutual Funds
Chapter 11
Retirement Plans and Mutual Funds

2. Session Overview
Selling funds through retirement plans is a multi-step process.
Retirement plans provide significant tax benefits.
Defined contribution plans and individual retirement accounts have become key components of the U.S. retirement savings system.
Target date funds provide an asset allocation that becomes less risky as investors near retirement.
The U.S. retirement system faces challenges in the decades ahead.

3. US Retirement

4. Retirement Resource Pyramid
Social Security is the largest component of retiree income and the primary source of income for lower income retirees.
Payroll tax (12.4%); 6.2% paid by employees and 6.2% covered by employers.
For the lowest quintile of households ranked by lifetime earnings, Social Security will replace 83% of inflation-indexed lifetime earnings.
Even for top 20%, it is 33%

5. Near-retiree Households Across All Income Groups
Percentage of near-retiree households by income groups have retirement assets

6. Retirement Resources Outside Social Security

7. Primary Reason for Household Saving
Percentage of household by age of household head.

8. DB and DC: History and Growth of 401(k) Plans
Defined Benefit (Pension)
Retirement benefits are typically determined by the number of years (participant) and his/her salary.
These amounts are determined by a schedule and are fixed.
To finance this benefit, employer make regular contributions to an account dedicated to the DB plan.
Unique features:
Employer bears the risk.
Participants are highly dependent on the employer’s continuing ability to make contributions. (Bankruptcy???)
Lack of portability for DB plans.
Defined Contribution (401(k), 403(b), 457)
Employers have no obligation at all other than to provide to the plan.
In 401(k) plans, employers select the array of investment alternatives that will be available in the plan.
Employee bears risks in DC Plan.
Portability of DC plans.

9. Defined Benefit vs. Defined Contribution
Defined Benefit (DB)
Traditional pension plan.
Employer bears risk of making fixed benefit payments.
No portability; specific to company providing plan.
Becoming less common, especially with private employers.
Defined Contribution (DC)
401(k) plan is most common type.
Employee bears risk. Payout based on investment earnings.
Assets move with the employee.
Becoming more common.

10. Total US Retirement Assets and Unfunded Defined Plan Liabilities
Trillions of dollars, year-end 2017

11. Retirement and the Fund Industry
Retirement savings play a key role in the fund industry.
They make up nearly 40% of industry assets.
Funds play a key role in retirement savings.
More than half of all retirement plan assets were invested in mutual funds.
About 60% of assets in 401(k) plans and IRAs were invested in mutual funds.

12. DC Plan Assets by Type of Plan
Trillions of dollars, year-end 2017

13. Shift from DB to DC
Trillions of dollars, year-end 2017

14. Shift from DB to DC
More dramatic shift among private employers

15. Service Providers

16. Selling Fund Shares through a Retirement Plan
Employees choose one or more of the funds available.
Plan administrator provides employees with information on the options.
Employer chooses funds to include as investment options.
Plan administrator (often a fund sponsor) works with employer to establish a plan.

17. 401(k) Plan Contributions
Types of contributions to 401(k) plans:
Elective: Voluntary contributions by workers.
Usually in the form of salary reduction.
Matching: Employer contributions that match elective contributions.
Usually capped at a flat dollar amount or percentage of salary.
Non-elective: Contributions made by the employer to all participants.
Catch-up: Additional elective contributions for workers over age 50.
The cap may be lower for highly-compensated employees if the plan fails antidiscrimination tests.
These tests ensure that the highest-paid workers don’t benefit from the plan disproportionately.

18. Contribution Limits-401(k)

19. Tax Benefits of Qualified Retirement Plans
Employee contributions can generally be made on a Pre-tax basis
Employer contribution is deductible for employer.
Participants (= employees in the plan) don’t pay tax on employer contributions.
Participants can contribute some pre-tax income into the plan.
Earnings on contributions accumulate tax-free.
Vested contributions remain an employee not employer asset
DC assets are protected from bankruptcy
In short, participants pay taxes only when they withdraw money from the plan.

20. The Value of Tax Deferral to Employees

21. Other Retirement Options- IRA
It provides employees with a contributory retirement savings vehicle
To encourage people and small business to provide retirement plans by simplifying the rules applicable to tax-qualified plans

22. Limits on IRA Contributions
Roth contributions: Limited to workers with incomes below a specified amount.
Deductible IRA contributions: Limited to workers with incomes below a specified amount.
These income limits do not apply if neither the worker – nor the worker’s spouse – is covered by a retirement plan at work.
Workers may make non-deductible contributions to traditional IRAs, which still benefit from tax-free income accumulation.
Overall limit: Total contributions to Roth and traditional IRAs (both deductible and non- deductible) are capped.

23. IRA Assets
Trillions of dollars, year-end 2017

24. Contribution Limits-IRA

25. Qualified Plans To qualify for tax benefits, plans must:
Cover all employees meeting minimum age and length of service standards.
Provide benefits that don’t favor highly-paid employees.
Cap the level of contributions and benefits per employee.
Vest employee rights to benefits within a specified period.
Provide benefits for the employee’s spouse under certain circumstances.

26. Traditional IRAs vs. Roth IRAs
Contributions pre-tax
Earnings accumulate tax-free
Withdrawals are taxed
Roth
Contributions after-tax
Withdrawals are not taxed
Traditional IRAs may be converted to Roth IRAs.

27. IRA Assets
Rollover IRAs hold assets that have been transferred from – or rolled over from – an employer-sponsored retirement plan.
Rollovers now account for the bulk of assets added to IRAs every year.
Withdrawals from IRAs have been increasing as the U.S. population ages.
The Baby Boom is reaching retirement age.

28. Sources of Rollover Information

29. Target Date Funds Also known as life cycle funds.
Have experienced rapid growth.
Designed for retirement planning.
Investors choose a target date, which is roughly equal to their planned retirement date.
Gradually change asset allocation, reducing risk as they approach the target date.
The expected asset allocation is call the glide path.

30. Plan Administration Administrative services required for 401(k)s
Plan administrators must be able to:
Accept and keep track of different types of contributions.
Handle different types of distributions.
Calculate required minimum distributions.
Keep records of beneficiary provisions.
Process loans.
Provide reports to plan sponsors.
Accommodate non-mutual fund investment options.
Plan administrators may be fund sponsors or third parties.

31. The Future of Retirement Planning
Key issues:
Distribution planning.
As the population ages and moves into retirement.
Making plans simpler.
Greater use of default options to help participants with decision- making.
Ensuring retirement income security for all.
Providing access to a retirement plan for the 50% of workers (often lower income) who do not have it now.
Ensuring the financial viability of Social Security, which provides the majority of retirement income for two-thirds of Americans.

32. The DB-ification of the 401(k)
Key issues:
QDIA (Qualified Default Investment Alternative)
Target date
Managed account
Automatic savings features
Initial contribution
Periodic increases
Distribution planning
Automatic withdrawal features

33. Some other Issues: Some important mistakes made by employees
Some employees do not participate in a 401(k)
Many employees do not contribute enough to get the benefit of employer matching.
Younger employees often invest in money market funds and other conservative investments
Many employees fail to increase their contribution as their income rises
Qualified Default Investment Alternative (QDIA)
Default plan (authorized by government in 2007)
2/3 of the plans have a QDIA, of those plans, 91% have designated a target date fund as the default option.

34. Number of Investment Options in 401(k) Plans
Most plans have at least 3 options,
to avoid liability for investment choices made by employees

35. Impact of Choice

36. Some Academic Studies er
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