Annuities, Annuitization—Annuities are income contracts purchased from financial institutions. Typically used to provide guaranteed income in retirement, these contracts may be purchased before investors retire, upon retirement, or at some time later during retirement. The period between purchase and payout is called the accumulation phase; the period in which the contract pays investors is called the annuitization phase.
Automaticity—The creation of default options, most typically the automatic placement of workers into savings plans and into investment strategies that aim to benefit their long-term prospects for financial security in retirement. Examples include auto-enrollment, auto allocation, auto-escalation of deferrals, and automatic engagement of guaranteed income solutions in retirement. The full suite of automatic choices is sometimes termed “full auto.”
Auto-IRA—Principle by which workers may be automatically enrolled into Individual Retirement Accounts (IRAs) in the workplace. Currently being rolled out in several states for workers without access to private workplace defined contribution savings plans.
Behavioral Economics/Behavioral Finance—the application of psychological and sociological principles as a means of analyzing financial decision making and behaviors such as savings plan enrollment, asset allocation, risk engagement, and risk tolerance.
Birthright Retirement Accounts—This concept would have the federal government establish a small savings account for every newborn child in America, effectively creating a lifelong investment glide path for retirement.
Choice Architecture—A behavioral finance principle in which savings and investment options are presented in a manner designed to guide workers to optimal choices. Examples include automatic enrollment, opt-outs, and automatic allocation to risk-managed investments.
Contingent Labor—Workers other than full-time employees, employed as contractors, consultants, freelancers, or temporary contract workers. These workers pay both employer and employee portions of Social Security payroll taxes and do not participate in employer-sponsored workplace savings plans. These workers are often described as participating in the “gig economy.”
Coverage Gap—The persistent shortfall of worker coverage by workplace retirement savings plans. Many small employers cannot afford to administer ERISA-compliant workplace savings plans. As many as half of American workers fall into this gap.
Deferred Income Annuities (Longevity Annuities)—Also known as DIAs, these are income contracts between investors and insurance companies in which investors purchase the annuity on a given date and then begin collecting guaranteed lifetime income beginning years or decades later. DIAs allow retirees to keep more assets in risky markets like stocks because the pending DIA effectively mitigates overall portfolio risk.
Defined Benefit Plans (pension plans)—Pension plans in which benefits are determined by length of service and salary. Pension fund trustees own and invest assets, providing promised benefits that terminate upon death.
Defined Contribution Plans—workplace savings plans for retirement, education, and healthcare defined by volume of income deferred and invested, rather than by level of benefits earned by pension fund membership. Accumulated assets are owned and invested by workers and may be passed on to heirs.
Dependency Ratio (Support Ratio)—Economists contrast the number of workers currently in the labor force with those out of the labor force (retirees) and use this ratio to gauge the sustainability of retirement finance architecture. When traditional pensions were established generations ago, there were many workers for each retiree; today this ratio is aggressively narrowing, drawing into question the sustainability of the retirement finance architecture. For example, in 1950 the U.S. support ratio was 16:1; today it is 3:1, and in 2035 it will be 2:1.
Employment Retirement Income Security Act of 1974 (ERISA)—This federal law established minimum standards for private pensions and provided federal income tax rules associated with employee benefit plans. ERISA obliged plans sponsors to disclose information to beneficiaries, established standards and practices for plan fiduciaries, designated regulatory responsibilities for the federal Departments of Labor and Treasury and the Pension Benefit Guaranty Corporation (PBGC), and provided for legal remedy in the federal courts.
Financial Literacy—A basic understanding of personal finance topics including retirement finance, investment, insurance, educational finance, tax planning, etc. Observing that many individuals persist in making suboptimal financial choices, many industry experts have concluded that consumers would be better served by behavioral finance principles that guide them to more optimal decision making and planning rather than by expensive educational programs that have limited impact.
Income Replacement Ratio—Retirement income divided by working income. Used as a measure of the adequacy of annuitized retirement savings.
Individual Retirement Account (IRA)—IRAs are tax-advantaged retirement investment accounts typically invested in target date funds, mutual funds, or other securities. Unlike 401(k)s, which are accounts sponsored by employers, IRAs are standalone accounts that individuals open on their own.
Lifetime Income Score (LIS)—This research, undertaken by Empower Retirement and Brightwork Partners, takes into account all sources of future retiree financial benefits—Social Security, traditional pensions, defined contribution workplace savings plans such as 401(k)s, savings, insurance, home equity, and shares in business ownership. LIS surveys calculate replacement percentages of preretirement income, noting the positive impacts of access to workplace savings plans, automatic enrollment, automatic savings escalation, and work with financial advisors.
Longevity Risk—Any financial risk related to increasing life expectancy. Insurance companies calculate whether their policies can profitably stand behind their guarantees. Pension funds must calculate whether they have sufficient funds to comply with benefits promised to their pensioners. Individual retirement savers must calculate whether they have accumulated sufficient financial assets, together with their Social Security benefits, to provide for themselves in retirement. As global longevity increases, all of these systems are strained worldwide.
Modern Portfolio Theory (MPT)—A foundational predicate of modern pension fund investing, MPT helps investors to optimize the returns that they can expect from a given level of risk. MPT established that returns and risk are inherently linked. This in turn allowed organizations and individuals to calibrate their desire for returns with their risk tolerance.
Multiple Employer Plans (MEPs)—MEPs are workplace savings plans sponsored by groups of employers, rather than single employers. MEPs promise economies of scale and efficiencies that can drive down the administrative burdens and cost of workplace savings plans. MEPs have traditionally been limited to related groups of employers (such as industry associations). Many retirement policy experts are calling for the establishment of “open MEPs” that would dramatically increase their usage, offering sustainable workplace savings plans to workers at small employers that cannot independently afford to establish ERISA-compliant plans such as 401(k)s.
Nudge Economics—In behavioral economics, a nudge is a kind of positive reinforcement that can be engineered to urge individuals or groups to make decisions. Typically seen as an efficient alternative to regulations, mandates, and enforcement, a nudge offers incentives such as tax credits and regulatory relief to individuals or groups. In retirement savings, nudges like automatic enrollment, deferral, and allocation have resulted in dramatically improved financial results as compared with purely voluntary offerings.
Pay-as-You-Go Plans (PAYGO)—Generally speaking, private company pensions and U.S. state-government employee pensions are supported by an investment fund that finances pension payouts. Many traditional public-sector pension funds are unfunded. For example, U.S. government defined benefit pensions are paid out of current tax receipts. Many government pensions around the world are also pay-as-you-go.
Pension Protection Act of 2006 (PPA)—The PPA capped 20 years of retirement policy evolution by endorsing a series of best practices in workplace savings plans that had been inspired by behavioral finance research and experiments by a handful of progressive plan sponsors. The PPA, in effect, marked the first time that Congress and top policy makers recognized defined contribution plans as the primary source of future retirement income and acted to treat these plans as a system.
Qualified Default Investment Options (QDIAs)—The Pension Protection Act of 2006 established legal safe harbor for ERISA-compliant workplace savings plans that undertook auto-enrollment into “qualified” stable value funds, balanced funds, target date funds, and managed accounts.
Retirement Readiness—This term describes a holistic preparation for retirement that includes retirement savings, Social Security, healthcare insurance, Medicare, housing, and other factors. Investors and their advisors should factor in their entire financial circumstance—assets, benefits, and liabilities—in assessing retirement readiness.
Revenue Act of 1978—This rather humble legislation was primarily dedicated to routine administrative elements like widening tax brackets and reducing the number of tax rates in the U.S. Internal Revenue code. But the law also added a section 401(k) to the Internal Revenue Code that reinvented America’s multitrillion-dollar retirement finance system by launching the defined contribution workplace savings revolution.
Section 401(k)—A provision of the Revenue Act of 1978 that was intended to allow companies to offer pretax savings plans as supplements to traditional pensions—but opened the way to the creation of today’s multitrillion-dollar 401(k) industry, which has become the primary source for most working Americans’ future retirement income.
Sequence-of-Returns Risk—Retirement savings investors must be concerned with a little-known and potentially dangerous risk regarding the “sequence of returns”—meaning outsized gains or huge losses—in financial markets in the years just after retirement.
Target Date Funds (TDFs)—These investment funds, typically used by retirement and education savers, are built around an investment algorithm that evolves investment exposures along a “glide path.” Funds engage high-return, high-risk equities early in the investment period, gradually shifting exposure toward lower-risk fixed-income securities as target dates approach.
Workplace Savings 1.0—The initial surge of defined contribution savings plan adoption beginning in the early 1980s as many companies converted to 401(k)-style payroll deduction plans. This period was marked by purely voluntary enrollment, steadily expanding investment options, and a risk shift from companies to individuals. This raised the number of DC savers past the number of DB plan participants by about 1985.
Workplace Savings 2.0—From the early 1990s to 2006, this period saw the emergence of target date funds and their embedded advice and “glide paths” as a prime choice for plan defaults. It also saw early experiments with auto-enrollment and savings escalation.
Workplace Savings 3.0—The Pension Protection Act of 2006 launched a qualitatively new phase in workplace savings by endorsing automatic plan design as valid and guiding plan participants to improved default choices of target date and balanced funds that offer much improved chances of attaining retirement readiness. PPA also offers strong legal “safe harbor” protection to plan sponsors who adopt these design features. We are yet to fully implement such automatic designs across all existing workplace savings plans.
Workplace Savings 4.0—This is a next generation series of improvements to workplace plans that is already emerging in the marketplace as progressive plan sponsors introduce lifetime income options into plans along with healthcare cost and peer comparison tools to spur higher savings. A new industry norm of 10-percent-plus savings deferrals is also emerging. But realizing the full potential of Empower Retirement’s Workplace Savings 4.0 vision will require new legislation, wise regulatory support, and even stronger safe harbors. The reforms proposed in the 4.0 model would, if adopted, substantially solve America’s retirement savings challenge.