IRS changes the 401(k) rules for 2015

Hailey Lee | @haileylee139

Thursday, 23 Oct 2014 | 2:40 PM ETCNBC.com

 

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Taxpayers are about to get a bit more elbow room for retirement savings. Many contribution limits for employees with tax-favored retirement savings accounts were expanded for 2015, the Internal Revenue Service said Thursday.

The maximum for contributions in the government's Thrift Savings Plan, private sector 401(k)s and other comparable programs have been raised to $18,000, up from $17,500 in 2014 and 2013. For people over 50 years old, the "catch-up contribution" threshold has been increased from $5,500 to $6,000.

"You look at the $18,000 and wonder, gee, how many people can practically get to that level?" said Joe Ready, director of Wells Fargo Institutional Retirement and Trust. But as people "progress in their careers and earnings progressively go up," it will be increasingly important for elderly investors to max out the $24,000 limit, he said.

That's the combined total investment limit for people 50 and older—$18,000 for the 401(k) plus $6,000 for catch up.

Kenishirotie | Getty Images

 

"For those over 50 years of age—a group that needs to be far more aggressive about saving—the fact that they can get $24,000 a year in contribution is a strong message for them to save at a significant rate," said Kevin Crain, Bank of America Merrill Lynch's managing director with more than 30 years of experience in the retirement industry.

"If you look back to 2009, limits on 401(k) were around $16,000. These aren't huge bumps but it's slowly incrementing upwards and it's a nice message on the opportunity and power to save," Crain said.

If a worker is investing in both an after-tax Roth TSP (where withdrawals are tax-free), as well as a pretax TSP, then the $18,000 contribution limit applies to the amalgamation of both accounts.
For small business owners and self-employed workers that invest in an SEP-IRA or a single 401(k), the 2015 annual contribution limit rises to $53,000, a jump from $52,000 in 2014.
People who max out their contributions remain a minority but that group is growing, Crain said. In general, about 15 to 20 percent of active contributors max out their contribution limit, he said.

Some programs are unchanged. For Individual Retirement Accounts, the $5,500 limit will stay the same for 2015. Annual benefits from a defined benefit plan will stay at $210,000.
The adjustments were triggered by an increase in cost-of-living expenses. The secretary of the Treasury is required to adjust limits annually to reflect cost-of-living increases.

Read MoreSocial Security benefits will increase by 1.7%

Here is the IRS's full list of pension plan adjustments for 2015.

Finding, and Battling, the Hidden Costs of 401(k) Plans

John F. Wasik

Friday, 7 Nov 2014 | 10:35 AM ETThe New York Times

Like millions of retirees who assumed their companies had taken care of them, Ronald Tussey never thought that his retirement plan might be flawed. He trusted his company so much he kept his money in his 401(k) long after he left.

Having worked as an engineer for 37 years, ultimately at ABB Inc., where he retired 11 years ago, Mr. Tussey said he never paid much attention to the fees in his retirement plan and "assumed the company was looking out for my best interests."

But after seeing a television program on the negative impact that 401(k) expenses can have on retirement savings, he hired a lawyer, who filed a class-action lawsuit in 2006 against ABB and plan administrators.

August Kryger | The New York Times

 

Ronald Tussey, whose lawsuit against a former employer became a landmark case highlighting expenses in 401(k) plans, at his home in Lake Ozark, Mo., Nov. 6, 2014.

Mr. Tussey's suit became a landmark case that highlighted the sometimes excessive expenses in 401(k) plans. The suit remains largely unresolved today, while Mr. Tussey has become an archetype of an inexperienced litigant caught up in a legal battle far more complex than he ever expected.
"I had no idea about litigation," Mr. Tussey says. "It was unbelievable."


Like many employees, Mr. Tussey, now 70, was told that his retirement plan was "free," even though middlemen were deducting expenses from his savings.
In many retirement plans, a significant amount of future retirees' funds are devoured by fees. According to a 2012 study published by the progressive think tank Demos, high 401(k) fees can drain $155,000 from an average household over a lifetime. Higher-earning households can lose even more — up to $278,000.

Growing employee resistance, resulting from a greater awareness of plan costs, has resulted in more than 30 lawsuits against 401(k) plans and employers since 2006. Seventeen have been dismissed, but these suits are time-consuming, complex and difficult to litigate. The oldest 401(k) suits, like Mr. Tussey's, have been winding through courtrooms for the last half decade.

Despite a federal requirement that plan fees be disclosed and numerous reports on 401(k) plan flaws, few employees question how much they are being charged, much less take their employers to court. As Mr. Tussey learned, time spent on legal proceedings is clearly not on a par with time spent traveling the world, working in the community or taking up a new hobby.

After more than six years of litigation, a federal court in Missouri ruled in March 2012 that ABB and its record keeper, Fidelity Investments, violated fiduciary duties to the plan and participants and were liable for $37 million.

ABB appealed part of the case, but the United States Court of Appeals for the Eighth Circuit in St. Louis this year upheld the Federal District Court judgment that $13.4 million be awarded to participants.

A $1.7 million district court judgment against Fidelity was reversed by the higher court.
Nothing, to date, has been paid to ABB 401(k) plan participants. Lawyers representing the employees want the Supreme Court to review the case.
In the meantime, though, there are lessons here for current and future retirees.

David Franklin | E+ | Getty Images

 

At the heart of the suits are a raft of obscure fees and services that few employees will be able to discern. Unless employers absorb all of the expenses, you must pay the bills for plan record-keeping, administration and fund management.
Most fund expenses not covered by employers are deducted from plan assets — the money pooled for your retirement — and show up in an "expense ratio," which is expressed as an annual percentage of what you have invested. If your plan charges 1 percent on $100,000 invested, you are paying $1,000 annually in fees.



How much is too much for 401(k) expenses? It depends on the size and complexity of the plan. The Department of Labor's fee disclosure requirement, which went into effect about two years ago, will tell you how much is being deducted from your savings, but it won't tell you if that amount is too much.

In the somewhat opaque world of 401(k) expenses, a large plan may be the best deal, but smaller plans can still offer lower expenses if employers shop around. Often only an audit by an independent fiduciary who knows how to compare similar plans can determine whether you are being overcharged.

Jerome J. Schlichter, a St. Louis lawyer who represented Mr. Tussey and plaintiffs in other 401(k) suits, said there were some common elements in plans that could indicate lofty expenses and conflicts.

Even though no extra service may be provided, record keepers may reap higher compensation just because total assets increase from year to year. This number can be hard to find and even tougher to examine. Is your plan's record-keeping fee fair? You may need an independent consultant — someone with no financial interest in the plan, funds or middlemen — to properly vet this number.
Also look at revenue sharing. This is an often complex arrangement where a fund manager "shares" some of the fees it receives from fund expenses with other service providers, such as brokers. This practice, though declining, is particularly insidious since it provides little or no value to employees. It is derisively referred to as a "kickback" by 401(k) critics.

Expenses, perhaps the largest target for 401(k) suits, can be the easiest to vet because fees can be compared across plans and funds. Does your plan charge a "retail" fund fee? It shouldn't because 401(k)'s, even small ones, have access to the lowest-cost "institutional" or exchange-traded funds, which charge as little as 0.04 percent annually.

If your fund company offers multiple "share" classes, you will also need to know if you are getting the least expensive class. To get a basic idea, compare your plan with similar 401(k)'s on Brightscope.com. You can also look up individual fund expenses on Morningstar.com.
You will also need to see what kinds of funds are in your plan. Is your employer, particularly if it's a financial services company, offering "in-house" or "proprietary" mutual funds? They may be more expensive than other funds and pose clear conflicts of interest.
And keep an eye out for unnecessary fees that may be eating up your nest egg. These include commissions, also known as "loads," 12b-1 marketing fees, insurance-related charges, "wrap" fees and transaction expenses.

Even if you are acutely attentive to financial details or can fathom the arcane language of annual plan statements like 5500 forms, this is tough. Except for fund management fees, it's not easy to spot a blatant overcharge. Mr. Schlichter has found that even in a new era of plan disclosure, most employees "are not aware of these fees and don't learn much from their plan statements."

For help, you might want to consult outside resources, like the website Personal Capital. The online money manager has a free 401(k) Fee Analyzer. It will tell you how expenses are affecting your nest egg.

The Department of Labor's website has a wealth of information on 401(k) fees and disclosure, and you can also find a breakdown of 401(k) expenses at Bankrate.com.


What if you've found that your plan is a rotten deal, but you don't want to move your money and can't get your employer to change the plan?
As Mr. Tussey knows, it may be a long, rocky road through the court system, at the end of which you may not reap a penny.

Lawyers representing employees must prove not only that plan participants were charged exorbitant fees or employers showed a clear conflict of interest, but also that employers broke federal law by breaching their fiduciary duty. That's a legal standard that says employers must do everything in their power to act prudently on behalf of workers. In the case of 401(k) plans, that means finding a reasonable selection of low-cost funds and services.
But the legal landscape may change substantially. In October, the Supreme Court agreed to hear a 401(k) fee case. If the court rules in favor of employees, the floodgates could open for more retirement plan lawsuits.

It pays to shop around for health-care plans

If you've spent more time examining holiday sales ads than your open enrollment insurance materials, you're not alone.

A new survey from Aflac found that last year, 41 percent of employees spent less than 15 minutes researching benefits options during their employers' enrollment window—compared with an average two hours deciding which TV to buy. That can be a costly mistake.

Unless you're buying a top-of-the-line $4,000 set, health care is going to be the pricier financial decision. This year, the average worker paid out $4,823 in premiums, 3 percent more than in 2013, according to the Kaiser Family Foundation. And experts say more increases are in store for the coming year, so the plan you choose can make a big difference to your bottom line.

"This is a year where employers are making a lot of changes," said Beth Umland, director of research for health and benefits at Mercer, an HR consulting firm. "If you're ever going to read your open enrollment materials, this is the year to do it."

Robyn Beck | AFP | Getty Images

 

Health Care insurance options in California.

 

Not only can consumers expect to see more premium and deductible increases, but they may also see more low-premium, high-deductible plans (often called consumer-driven health plans). There may also be surcharges for coverage of a spouse and more incentives for healthy behaviors.
Those trends mean it's smart to use open enrollment to reassess—even if you like your current plan, said Craig Rosenberg, practice leader for health and welfare benefits administration at Aon Hewitt. You might find one that's less expensive or a better fit for your health-care needs.

"Don't buy on price alone," said Rosenberg. "You may find that the plan that costs you the least to purchase ends up costing you the most, with your health-care needs." Instead, assess how you used your plan this year, and look at how the premiums, deductibles and other costs of the plan offerings add up.

Families might find that the best value requires each spouse to find coverage through their respective employers, instead of signing on for one family plan. Employers often cover a lower percentage of health-care premiums for families than they do for individuals, and some are adding on surcharges to cover a spouse who has access to health-care elsewhere, said Tracy Watts, national health-care reform leader for Mercer. The median surcharge is $100 per month.

Don't forget to look at other voluntary benefits. Experts say open enrollment might be your only chance to opt in for employer-sponsored disability insurance, or, if you're looking at one of the high-deductible plans, hospital indemnity coverage to help cover costs if you unexpectedly end up in the emergency room.

Kelli B. Grant 

Personal Finance and Consumer Spending Reporter

Nest Egg is Breaking...

BlackRock's Fink sees nest egg problems as wave of retirees loom

Katie Kramer | @Kramer_Katie

Sunday, 19 Oct 2014 | 9:00 AM ETCNBC.com

The American retirement crisis is here, said Larry Fink, the man who runs the world's largest money manager.

The CEO, chairman and co-founder of BlackRock, which had $4.3 trillion in assets under management through the end of last year—a number that surpassed the U.S. federal budget for 2014—issued a stark warning to the wave of retirees expected to draw government benefits in the coming decades. Fink believes not enough Americans have prepared for their sunset years, and it will eventually cost them and the government.

"Too many Americans are too dependent on Social Security," Fink told CNBC, contending the federal program was designed to be a backdrop to other private savings.

"To build a proper savings for retirement requires saving continuously through life," said Fink. A later start to savings, combined with Americans' increased life expectancy leaves many ill-equipped to live twenty to thirty years of retirement "in dignity."

Adam Jeffery | CNBC 

 

Larry Fink, Chairman & CEO of BlackRock

 

According the U.S. Census Bureau, 35 percent of Americans over age 65 rely entirely on Social Security's monthly benefit, and 36 percent of the general population don't save anything at all for retirement. That number rises to over 50 percent for workers under age 30.


Perhaps an even scarier number is the 80 percent of people aged 30-54 believe they will not have enough money put away from retirement, according Census Bureau data. Fink attributes this bleak condition in part to private companies' failure to inform employees about the importance of saving for retirement.

"We have to be noisier in the private sector," says Fink, whose firm employs more than 11,000 workers. "The business community is at risk for not educating their employees."
He took issue with the defined contribution model of retirement savings, which places the responsibility for accruing savings on employees.


"Each individual tend(s) to live their life more for today than in the future," Fink said. "Saving for a thirty to forty year outcome is not a front and center priority," he said, when the cost of housing and private education is on the rise.

However, Fink argued it's a problem that cannot be ignored. He believes a long-term investment and savings strategy is the surest way to avoid the fear of not having enough and build a proper nest egg.
"One of the fundamental problems with individuals is they watch the news—whether it's Ebola, whether it's the volatility in the world, whether it's ISIS—they become frightened, and they pull back their investments to, maybe, more in cash," Fink said.

That conservatism, combined with large swaths of the public that don't invest in the first place, may mean missing out on long-term earnings for a nest egg.

"If you believe that the U.S. is the best place to invest over 40 years," Fink said. "You're probably going to be able to assume 6 to 8 percent compounding rate over a long time, owning equities."

Katie KramerCNBC Producer, "On the Money"

Overlooked health-care costs can destroy retirement planning

Shelly K. Schwartz, Special to CNBC.com

Monday, 4 Nov 2013 | 8:00 AM ET

Jill Fromer | E+ | Getty Images

 

It's not inflation or even market performance that presents the biggest risk to your retirement plan. It's unexpected medical expenses.

Indeed, health-care costs are often overlooked—or underestimated—by pre-retirees who are putting money away.
"As we age and live longer, our health deteriorates pretty heavily in the last five to seven years of life, and that's when we spend a ton of money," said Bob FitzSimmons, certified financial planner and president of Bob FitzSimmons Inc., a wealth management firm.

"I have quite a few clients who have burned through their capital in assisted-living facilities, spending $200,000 to $300,000. Generally, it's the adult children who have to come to the rescue."

According to the Employee Benefit Research Institute (EBRI), a 65-year-old couple with median prescription-drug expenses who retire this year will need $295,000 to enjoy a 75 percent chance of being able to pay all their remaining lifetime medical bills, and $360,000 to have a 90 percent chance.
Those figures factor in the premiums for Medigap and Medicare Part D outpatient drug benefits to supplement basic Medicare, along with out-of-pocket expenses for prescription drugs. They do not include the cost of nursing homes or long-term care insurance. 

A 2013 study by Fidelity Investments, however, found that 48 percent of respondents, ages 55 to 65, believe they will need just $50,000 to pay for health-care costs in retirement.

Many assume that Medicare, the federal health-insurance program for those 65 and older, will cover the rest. Not so, financial experts say.


According to EBRI, Medicare currently covers only 62 percent of the expenses associated with health-care services. And seniors can expect to pay a greater share of their costs, as Medicare limits coverage and employment-based retiree health programs disappear.


"There's a huge gap between what people are planning for and what they will actually need to pay out of pocket," said Laura Bos, vice president of financial security, education and outreach at AARP. "It can be quite the sticker shock."

Make projections: The best way to ensure that future health-care costs don't consume your savings is to determine within a reasonable degree of accuracy how much you may need, financial advisors say.
That figure fluctuates, based on your current health, lifestyle and family history. It also varies depending on who's crunching the numbers.


Fidelity Investments, for example, estimates a 65-year-old couple retiring this year will need roughly $220,000 to cover medical expenses, not including long-term care insurance throughout retirement. This is slightly less than EBRI projects.


"Start with an estimate for the national average and then take a look at your family history," said Donald Roy, a certified financial planner with New England Wealth Advisors. "Maybe your mom ended up being diabetic late in life, or your dad has a history of heart problems. Some people are more exposed to health risks than others."


Financial advisors frequently have access to tools that provide a health-adjusted life expectancy. But you can estimate that number on your own using the age-based life expectancy calculator from the Social Security Administration, adjusting the result to account for personal health history.

Invest for growth: You should also earmark a separate account for retirement savings and invest those dollars for growth, FitzSimmons said.


"That can be difficult for retirees who worry that they may not have the time horizon to ride out a crisis like we saw in 2008," he said. "They won't let themselves take on risk, but that's your best protection against rising costs."


Unless your savings are sufficient to cover projected health-care costs, FitzSimmons said, the bigger risk is being too conservative with your portfolio.

Indeed, PricewaterhouseCoopers Health Research Institute reports the health-care cost inflation rate is projected to be 6.5 percent in 2014, down from 7.5 percent this year.

Thus, the traditional safe-haven investments favored by retirees, such as money market funds and Treasurys, which currently yield less than 4 percent, would fail to keep up with health-care inflation. That's a guaranteed loss of purchasing power.

Medigap: Medigap supplemental insurance, sold by private insurance companies, can also help cover some of the health-care costs not paid by Medicare, such as copayments and deductibles. According to AARP, Medicare beneficiaries spend an average of $4,600 a year out of pocket.

To purchase a Medigap policy, you must have Medicare Part A and Part B. Medigap rates vary widely but can cost up to $175 per month, which you pay in addition to the premium for Medicare Part B. (The average Part B monthly premium is $104.90, according to Medicare.)

Keep in mind, however, that Medigap does not cover everything. It excludes long-term care insurance, vision and dental care, hearing aids, eyeglasses and private duty nursing.

Long-term care insurance: You can create an additional financial safety net with long-term care insurance. Such policies are designed to cover long-term services and support, including assisted living, home care, adult day care and hospice—things traditional health insurance doesn't cover.

"Long-term care services can cost hundreds of thousands of dollars, so long-term care insurance is certainly something to consider," said AARP's Bos.

Not everyone requires assisted living in their later years, however, and long-term care coverage does not come cheap.


As such, it's important to consider how much money you already have set aside for health-care costs and purchase only the amount of coverage you actually need, according to the Department of Health and Human Services.


You may have enough income, for example, to pay a portion of future costs and purchase only a small policy to cover the balance.

Make sure, too, that you can afford the policy payments over time as your monthly income changes, HHS advises.


If you do plan to buy, don't wait too long.


When you start having health problems, health insurance companies may deny you coverage for long-term care coverage, financial experts say. You also will pay increasingly higher premiums as you grow older.


The LTC insurance calculator provided by Genworth Financial shows that annual premiums for a 50-year-old female are roughly $1,636, but $3,657 for a female age 65.

Health savings accounts: If you're still earning a paycheck, and your employer offers a high-deductible health plan, you are also eligible to establish a health savings account (HSA).

HSAs are funded with pretax dollars, the earnings grow tax-free and your withdrawals are tax-free, if used for qualifying medical expenses. Any money you accumulate in the HSA can be used as needed, or saved to help offset future medical expenses during retirement.


The account is also portable, meaning it comes with you if you change employers or quit your job.

"I always ask my clients what they have available at work by way of health insurance, and if they have an HSA, we try to utilize it," Roy said. "The tax deductions help and if it does build some value down the road, they can use it to support some of those medical costs in retirement."

There are limits, however, to how much you can contribute each year to an HSA. In 2013, individuals can save up to $3,250 and families can save $6,450. Those 55 and older can save an extra $1,000.


Don't retire too early: The other big factor that impacts your ability to meet future medical expenses is the age at which you retire.

Those who quit their job before they are eligible for Medicare at age 65 typically have to purchase private health insurance to bridge the gap.

That can amount to $15,000 a year or more, said Roy, which can quickly deplete the savings you reserved for health-care costs.


An early retirement, he noted, also deprives you of those crucial extra years to sock money away.

A 60-year-old with a 401(k) that's worth $500,000 and earns 7.5 percent interest a year, for example, could grow his or her nest egg an additional 66 percent, to $832,392, by continuing to make the maximum monthly contribution for five more years, said Roy.

"People are often shocked when they figure out what private health insurance will cost them," he said. "They don't always have a good understanding of how much their employer is subsidizing."

Unexpected medical costs can derail your retirement plan faster than you can say "hip replacement."


The best way to avoid a savings shortfall is to plan ahead, invest for growth and use supplemental insurance, where appropriate, to pick up where Medicare leaves off, experts say.

"Planning for health-care costs in retirement is critical," Bos said. "Sit down, run the numbers and have a realistic picture of what it's going to cost you."


—By Shelly K. Schwartz Special to CNBC.com

Older Americans are ill-prepared for hefty health-care costs: Study

Kelley Holland | @KKelleyHolland

Wednesday, 15 Oct 2014 | 7:01 AM ET CNBC.com

Pali Rao | E+ | Getty Images 

Older Americans are increasingly worried about the health-care costs in their future, but few are taking steps in response.

That's the finding of a study released Wednesday by Ameriprise Financial, which found that 53 percent of baby boomers say they are "very concerned" about health-care costs in retirement.
They have reason to worry: a couple, both aged 65 and with typical prescription drug expenses, would need to have $255,000 in health-care savings to be 90 percent certain they can cover their expenses, according to the Employee Benefit Research Institute, or EBRI.
Even so, only 19 percent of the survey respondents said they were taking steps to prepare financially for their health-care costs in retirement.

There are a few bright spots for boomers facing retirement. EBRI's projections of health-care costs for retirees have fallen for two years in a row, for one thing. And while only 21 percent of the respondents in Ameriprise's new survey have purchased long-term care insurance, that figure is up from 13 percent a year earlier.


Pat O'Connell, executive vice president at Ameriprise, said he is encouraged that 88 percent of the survey respondents are aware that healthy lifestyle choices now will impact both their quality of life and financial well-being in retirement.
It is reasonable to look at the survey results "as a freight train bearing down on people," he said. "But to me, it would be a freight train you can do something about and get out of the way. People are thinking about doing something proactive."
Boomers have also gotten better at predicting their likely health-care costs in retirement, O'Connell said. "There is more coverage related to all issues of health care," he said, and for boomers in or near retirement, "this issue is becoming more and more relevant to them each year."

Carolyn McClanahan, a financial planner and former emergency medicine doctor in Jacksonville, Florida, said she takes her clients through a four-step process to help them prepare for health-care costs in retirement.

First, she has them determine what kind of health-care consumer they are. If they rarely visit the doctor and are in generally good health, they are likely to need less in health-care savings than if they go in for every hangnail and take a lot of prescription drugs.

McClanahan also encourages her clients to become empowered health-care consumers. When their doctors are prescribing tests, she teaches them to ask what the tests may show and whether the findings would change the treatment plan.
Advanced directives are McClanahan's third recommendation. (In the Ameriprise survey, only 32 percent of the respondents had such directives.) Usually when new clients come to her, they have not made their end-of-life wishes clear to their families; but now all but one of her clients has an advanced directive in place describing what they do and don't want doctors to do.
Without an advanced directive, "the default is to do everything, and everything is expensive," she said.

Fourth, McClanahan encourages clients to do what they can to take care of their health now.

McClanahan also discusses with her clients the advantages of working later in life. "Maintaining your human capital is the most important thing you can do to take care of your health," she said.
Continued employment may also let people continue with employer-sponsored health insurance. Given how little boomers are saving for health care, that's a prescription many of them may need.

Big US firms boost equity weightings in 401(k) target-date funds

Friday, 10 Oct 2014 | 5:47 AM ET Reuters

In changes that have raised the potential investment risks in many 401(k) retirement accounts, several major fund companies are increasing the stock allocation of their target date funds, which are used by many of those with such plans.


BlackRock, Fidelity Investments, and Pacific Investment Management Co. (Pimco)—all firms that have seen returns in their target date funds lagging competitors—have made adjustments in the past year so that 401(k) plan participants, particularly those who are younger to middle age, are more invested in equities. In some cases employees who are in their 40s now find themselves in funds that are 94 percent allocated into stocks, up more than 10 percentage points.

The changes have prompted concerns from consultants and analysts who worry that the fund managers are raising the risks too high for 401(k) investors as they seek higher returns, perhaps as a way to boost their own profiles against rivals.

Tara Moore | Taxi | Getty Images

 

This anxiety could grow if the recent decline in the U.S. stock market – the S&P 500 is down 4.5 percent since reaching an all-time high in mid-September and dropped more than 2 percent on Thursday – gains momentum. On the other hand, the increased bets on equities can be seen as a vote of confidence in the bull market, and are also a reflection of expectations of low returns from bonds in the next few years if interest rates climb.

"The shared characteristic these funds have is they have not been doing so well since 2008," said Janet Yang, a fund analyst at Morningstar. "The question is if the markets had gone down, would they have made these changes?"


For their part, executives at these firms say the changes are based on optimistic long-term forecasts for equities, lowered expectations for bond market returns and a better understanding of how much investors, particularly younger ones, rely on these funds as their primary retirement savings vehicle.

Target date funds contain a mix of assets, such as stocks and bonds and real estate, and automatically adjust that mix to be less risky as the target maturity date of the fund approaches. The idea is that retirement savers can choose a target date fund that lines up with their own expected retirement year and then not have to worry about managing their money.


These funds have increasing significance for retirement savers, because employers can and do automatically invest workers' savings in target date funds, though the workers can opt out. Some 41 percent of plan participants invest in these funds, up from 20 percent five years ago, according to the SPARK Institute, a Washington DC-based lobbyist for the retirement plan industry.

 

 

Nevertheless, the recent tilt towards heavier equity holdings raises questions about whether workers are entrusting professional money managers who might end up buying equities at or near market highs – the S&P is up 189 percent since March 2009.


"Our concern is that this is happening after a pretty good run in the equity market," said Lori Lucas, defined contribution practice leader at Callan Associates, a San Francisco-based consultant to institutional investors. "If it's a reaction to the fact that some target date funds haven't been competitive then it is a concern."

A more aggressive approach has worked for some funds in recent years.


The target date fund families of BlackRock, Fidelity and Pimco have performed among the bottom half of their peers over the last three and five year periods, according to Morningstar. Meanwhile, more aggressive target date fund families, like those managed by The Vanguard Group, T. Rowe Price and Capital Research & Management, ranked among the top half of their peers.

As of June 30, BlackRock's three-year return for its 2050 fund was 10.6 percent, according to Morningstar, compared with 10.16 percent for Fidelity's similar fund and 7.14 percent for Pimco's comparable fund. Meanwhile Capital Research's 2050 fund returned 13.27 percent and Vanguard's fund returned 12.26 percent for the same period.


Furthermore, with average expenses of 0.85 percent per year, these funds charge more than the 0.7 percent in fees levied by the typical actively managed balanced fund, according to Morningstar. The firms' pitch is that investors are paying more for peace of mind and a set-it-and-forget it approach to managing their retirement money. Workers willing to make their own mix of indexed stock and bond funds could pay considerably less. The average expense ratio for an equity index fund is 0.13 percent and 0.12 percent for a bond index fund.


"There is some kind of expectation that we are making these changes because of the equity markets or because of what competitors are doing and that is incorrect," said Chip Castille, head of BlackRock's U.S. retirement group.


BlackRock decided to make its changes after a four-year research project cast new light on how younger workers look at their plans. Previously, BlackRock's funds were focused on making sure that investors had enough at retirement. But given that employees' wages tend to be flat or go up in value slowly, like a bond, BlackRock wanted to make sure that the target date funds were designed to provide greater returns during the course of employees' lifetimes, Castille said.

That, along with the firm's positive 10-year forecast for equities, resulted in the changes, he said.

Ryan McVay | Stone | Getty Images

 

With the BlackRock changes, which take effect next month, 401(k) participants with 25 years left until retirement will see their equity allocation jump to 94 percent from 78 percent. Investors at retirement age saw their equities allocation jump to 40 percent from 38 percent.

Executives at the firms note that the increases in equities all fit within the age appropriate risk for the investors, and that those investors close to or at retirement are seeing a very small bump in their equities weightings.


Also they note that they believe the changes will combat risks of not having enough money at retirement due to inflation and also address concerns that as people live longer they will need more in retirement.

Fidelity made its changes in January after it revamped its capital markets forecasts, which it revisits annually, said Mathew Jensen, the firm's director of target date strategies.
Specifically, Fidelity has lowered its forecasts for bond returns from 4 percent a year to 1 to 2 percent, not including inflation. That along, with internal research that showed that younger workers were not saving enough, led to the decision.

"None of our work was saying 'hey the equity markets did well, we should be in equities," Jensen said. "It was about if we have a dollar today, how do we want to put it to work based on what our capital markets assumptions are telling us."


Now an investor in Fidelity's 2020 fund has 62 percent invested in equities, compared with 55 percent previously, while an investor near or at retirement is 24 percent in equities, up from 20 percent.

Pimco raised the equity allocation in its target date funds late last year by 5 percentage points for some funds and 7.5 percentage points for others. The equity allocation for those at retirement is now 20 percent, up from 15 percent, while those investors planning to retire in 2050 saw their equity allocation jump to 62.5 percent up from 55 percent.


"The decision was supported by our view that the global macro environment had become more stable post the financial crisis," said John Miller, head of U.S. retirement at Pimco, in an e-mailed statement.