Retirement Spotlight Podcast
Silver Linings in Retirement PlanningRecorded April 29, 2020
Karyn McCormack: Welcome to "Retirement Spotlight", Lord Abbett's podcast series. This is Karyn McCormack.
Today, amid all the news about the COVID-19 pandemic we're going to focus on some silver linings, or bright spots, in the retirement world. We'll talk about some trends in defined contribution plans, as well as opportunities in individual retirement accounts that have caught our experts' attention during the recent market volatility.
I'm excited to have two of our retirement experts joining us today. We have a special guest, Steve Dopp, he's Lord Abbett's national director of defined contribution plans, and Brian Dobbis, Lord Abbett's direct of retirement solutions. Welcome Steven and Brian.
Karyn McCormack: Steve, let's start with you and your area of expertise, defined contribution plans. You wanted to talk about participant behavior. What are some of the trends you're seeing that have emerged during the COVID-19 crisis?
Steve Dopp: Yeah. Thanks for having me. And hopefully everybody is healthy and enjoying their time with their families. Yeah, Karyn, so, you know, obviously any time that there's tremendous market volatility-- our industry is concerned about leakage in plans. So participants making decisions poorly-- assets leaking out ofthe retirement plans. And certainly we've seen an uptick in terms of loans and hardship distributions.
An interesting piece of data came out from MorningStar-- which is positive, only 5.6 percent of people enrolled in 401(k) plans had changed their portfolio allocations in the first quarter. So that's definitely a positive trend.
Within the different asset classes, target date funds, not surprisingly tended to have lower changes inside of their accounts-- whereas core menu users-- you know, there's definitely been an increase in the amount of changes that are being made. Which, by the way, is not necessarily a bad thing, because funds are reallocating. It could be an opportunity where a participant had allowed their account maybe to sit and this gives them a chance to review is appropriately.
And then, probably the most important thing from an advisor's perspective is just the huge uptick in service calls and the experience that the record-keeping community is delivering to the plan participants.
Karyn McCormack: What are you hearing from the advisor community about how they're prioritizing their clients’ needs?
Steve Dopp: Yeah. You know, as I mentioned, I think-- on the front of most advisors that I've spoken to, minds, is, first and foremost, the service capacity of the record keepers. You know, upwards of 50 to 60 percent increase in service calls. And, obviously, we're living in an environment where we're all working remotely, we're all using different technologies and trying to find a way to make sure that you're continuing a consistent experience for the plan participants. It's certainly been their biggest concern.
The second thing I would say-- most advisors are- tending to lean toward the participants first. They want to make sure that they can do what's within their power to help encourage appropriate behavior, particularly in times of heightened volatility.
You know, as we record this, the market's being doing fairly well. We've bounced back pretty well off of our lows. So hopefully we're going to see a lot of that-- you know, the volume slow down a little bit. But, for the most part, I think-- you know, it's the service aspect of this.
Karyn McCormack: So, that brings us to the question about market volatility. How can they protect themselves against the uncertainty right now?
Steve Dopp: You know, and it's a good question and one that you know, most advisors have probably talked about for a long time. And that's, first and foremost, retirement plans aren't made to be short-term trading vehicles. They trade-- a daily valuation inside most mutual funds-- and so they're really designed for the long-term.
Secondly, you know, there's a lot of research done around dollar-cost averaging. We should continue to educate participants on the benefits of continuing to buy into the market when there is a tremendous amount of volatility because it is a long-term vehicle.
And then, you know, finally, I think just understanding the investments inside of the plan.You know, there's always been a disconnect between what we, as an industry, feel the experience should be to the plan participant and what the participant actually experiences within their retirement plan. So maybe a silver lining, you know, in your opening that you mentioned, is that this gives us all a chance to evaluate whether or not there can be adjustments made to the way that we deliver retirement plans to the end user and to the plan sponsors, right, in a more appropriate fashion.
Karyn McCormack: I should mention that for our listeners we have a very good article in the Defined Contribution area on our website about dollar-cost averaging. So I encourage everyone to check that out on LordAbbett.com/retirement or Defined Contribution area as well.
Steve, let's turn to investment trends. How have the traditional asset classes held up over the last few months?Steve Dopp: Yeah. And this has been the area where I think when the dust settles-- you know, we're really going to have to revaluate the--the architecture of retirement plans. There was a tremendous dislocation-- both in the fixed income part of the investment world, as well as the target data lifecycle area. So, the dispersion, and these numbers are a couple days old-- so, obviously, it changes. But the dispersion between 2020 target date funds has been dramatic. And particularly in March-- the worst performing target date fund provider lost over 20 percent of its value. And that's in a fund that is supposed to be managed to a participant that's going to retire this year. Whereas another 2020 fund was only down three percent. And so instead of just looking at what asset class you're trying to put inside of a plan, I think it's going to renew a focus on what's under the hood and how are we evaluating the different investments inside the asset classes.
And the second area where we've seen a tremendous amount of dislocation has been in fixed income. You know, between the different sectors that make up that marketplace-- you know, we tend to-- or participants probably tend to think of -- bonds as a very safe, or relatively safe, capital preservation vehicle. We saw a tremendous amount of divergence and performance, particularly with total return funds or intermediate-term bond funds where if you were very heavy in Treasuries you tended to perform very well. If you were more heavily invested in the credit markets you tended to perform more poorly. That doesn't mean either one is either less or more appropriate for a retirement plan. But just understanding how the different options within each individual asset class fit into the context of your architecture, I think, is going to become more important.
Karyn McCormack: Yeah. So how do fiduciaries evaluate that? Is it looking at the different boxes that MorningStar identifies, the style boxes from MorningStar?
Steve Dopp: Yeah. And again, this is probably another silver lining, you know, we have to take a look at how we traditionally build a core menu. We've historically done it through the MorningStar style boxes-- which is proven to be largely effective. Part of the Pension Protection Act referenced having different styles within your retirement plan.
But we have to look now, does it make sense to have, a large-cap value, large- or mid-cap value and mid- and small-cap value all in the same plan? You know, trying to determine whether just having one or two fixed income funds inside of a retirement plan, is that appropriate?
And then finally, stable value. I think people don't really understand, or participants certainly don't really understand, how those products work. And so we have to, again-- improve the experience of the plan participants. And that's going to be probably a major trend you're going to see coming out of the crisis.
Karyn McCormack: Speaking of trends, what are the areas of innovation you're seeing right now?
Steve Dopp: You know, it's interesting-- in late December they passed the SECURE Act, which, you know, a lot of service providers were scrambling to try to, first, understand it and second, how to respond to it. And you know, a couple of the areas where we feel that it's going to be a tremendous amount of product innovation-- the first one is lifetime income products.You know, they were considering to go as far as to endorse them inside of plans, but now annuities were mentioned in the SECURE Act. They provided a safe harbor. There isn't a very vast marketplace today of these types of products.
But they find a participant in the beginning of March and I'm going to retire this year, it sure would be nice to have some sort of annuity protection inside my retirement plan. So, I think that is certainly one area where you're going to start to see, when the dust settles, a lot of new trends emerge.
Karyn McCormack: Thank you, Steve. This is a really interesting time for advisors and plan sponsors. Right? And many lessons probably will come out of it. Thank you.
Brian, let's talk about individual investors. How can they navigate this volatile market environment in their retirement accounts? Are there any opportunities you're seeing?Brian Dobbis: Karyn, thank you for having me. And let me echo Steve's comments. I hope all our listeners are safe at home and spending some quality time with their family.
Let me also echo another one of Steve's comments: silver lining. One silver lining that takes on special importance in a volatile market is the discussion of whether or not to convert pretax assets to a Roth account. In a down or volatile market a smaller asset base means less amounts subject to income tax. In addition, couple that with historically low federal tax rates, all growth will then-- any recovery we have in the market will then potentially be distributed tax free, including earnings.
So just very brief example. If you convert $50,000 today of pretax money into a Roth account and then it grows to $75,000, you've just now had $25,000 potentially of tax-free growth. So, again, a down market does have a silver lining. Karyn, in addition, Roth accounts have other features that are very, very appealing, including no lifetime required minimum distributions.
And, upon the account owner's passing-- the beneficiaries inherit those assets tax free. So, if you're looking to leave an inheritance, a Roth IRA, very appealing as you're leaving tax-free money to your loved ones.
And then one last thing just thought I'd mention, Karyn. You know, the question regarding Roth conversions is always, first and foremost, taxes. Historically, we are in a very low tax environment. The lowest tax rate is ten percent. The top tax rate is only 37 percent. And, yes, listeners, I'm using air quotes. But the Tax Cut and Jobs Acts, which was passed in 2017, did not make those tax brackets permanent. Therefore, the low tax environment is only through 2025. If Congress doesn't act starting in tax year 2026, all tax brackets will revert back to pre-2018 rates, which, for most taxpayers, will be higher. In addition, with trillion dollar deficits it's more than possible, highly likely-- that taxes will only increase.
So a Roth conversion is a method, or a strategy, to hedge against higher taxes in the future. In essence, you're locking in today's low tax rates. But, again, this window of opportunity is just that: a window. Only through 2025.
Karyn McCormack: And, Brian, who's eligible to do a Roth conversion?
Brian Dobbis: Karyn, everybody is eligible to convert. There's no income tax, there's no age cap. Therefore, everyone regardless of income and/or age can convert to a Roth IRA.
Karyn McCormack: Now, Brian, is there a difference between a Roth 401(k) and a Roth IRA conversion?
Brian Dobbis: Yeah. There is. So everyone has the option of converting to a Roth IRA. A Roth IRA is pretty straightforward. Contact your IRA custodians. They send you some paperwork. Maybe you do the conversion over the phone with a customer service representative. Whereas in a 401(k) environment there must be a specific plan provision in your plan, known as an in plan Roth conversion, which would allow you to convert pretax dollars into a Roth account. If you're unsure if your 401(k) plan allows for conversions-- I would urge you to check your plan administrator, your HR department or your planned document to determine whether that's permissible.
Karyn McCormack: Now, for our listeners, are there anything-- any drawbacks, anything they should be concerned about?
Brian Dobbis: Well, the first thing is-- Roth conversions are subject to income tax, Karyn. So the first thing I would think, and the most important, is to ask yourself the following question: if I proceed with the conversion, do I have assets outside of the IRA to cover the additional taxes? And, if I do, where are those assets coming from? Meaning, do I have to sell off another asset to pay the taxes on a Roth conversion? Which then could be a domino effect.
So, first and foremost, do I have the assets to cover the taxes? Not-- and, ladies and gentlemen, not just on the federal level. If you're in a state with a state income tax, you also need to be cognizant of any state income tax liability.
In addition, Karyn, when you do a Roth conversion that is added to your income in the year of the conversion, which could impact a number of different benefits. For example, as I mentioned, you could be bumped into a higher tax bracket. You also-- for our folks that are on Medicare, it could increase your Medicare premiums. It could potentially subject your Social Security-- benefits-- taxation. You may be phased out of government-run deductions. You may be bumped into a higher tax bracket for capital gains taxes.
So, in essence, you kind of need to be holistic when you look at a Roth conversion, Karyn, for your whole financial plan. However, I think it's important for our listeners to be aware that there's a really interesting and popular strategy to potentially reduce or maybe even eliminate exposure to some of the aforementioned items. For example-- Karyn, a Roth conversion is not all-or-nothing. You can convert as little or as much as you want. I like the saying, "Convert until it hurts." Convert-- just enough maybe to stay in the same bracket. Convert just enough, your Medicare premiums don't get increased. And that's where you're working with a financial team, the financial advisor, the accountant, the CPA, to make those determinations or whether a Roth conversion is in your best interest and, if so, how much.
And Karyn, let me leave with this particular comment regarding Roth conversion. And it's very important. Roth conversion are final. They're irrevocable. You can't change your mind. So once you give the green light to the custodian to do the conversion, you are locked in. So, again, very important that you're aware that these are permanent. And Roth conversions-- ladies and gentlemen, it's not a one-size-fits-all. They're a very powerful vehicle. We urge you to speak with your financial team to determine whether or not they are appropriate for you and your family.Karyn McCormack: Brian, this is all great information. Thanks so much for joining us today. Thank you both, Steve and Brian, for talking with us today for our latest edition of "Retirement Spotlight".
Steve Dopp: Thank you for having me, Karyn.
Brian Dobbis: Yeah. Thank you for having me.
Karyn McCormack: Our listeners can find more information about defined contribution plans and individual retirement accounts on our website. Please see our articles at LordAbbett.com/RetirementPerspectives.
Advisors, if you have additional questions, please contact your Lord Abbett representative at 888-522-2388.
Individual investors, please contact your financial advisors and/or account if you have any questions.And you can also follow Lord Abbett on LinkedIn to see our updated retirement articles. Thank you for listening to our at-home edition of Retirement Spotlight. Hope you'll join us again soon. Ta-Ta for now.
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Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.
A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.
A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.
A target date fundis a mutual fund that allocates assets based on an intended retirement year. As investors get closer to their target retirement date, the fund’s investments shift from more aggressive to more conservative securities.
Dollar-cost averaging is a strategy by which a retirement plan participant places a fixed dollar amount into a given investment on a regular basis.