Retirement and Investment Solutions Newsletter

Insights

June 2010 Issue

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“Autos” Grow in Popularity

Many people are emerging from the market downturn with a newfound respect for the importance of saving and retirement readiness. Plan sponsors are taking advantage of this opportunity by making plan changes to boost 401(k) participation and deferral rates. 

The first way sponsors are helping participants is by implementing automatic enrollment. We’re seeing this with our clients; although, the addition of automatic enrollment grew at a more modest pace than in previous years. 

2010 RPS Insights June Chart


Automatic Enrollment Adoption Rate of Active Qualified Plans

Source: J.P. Morgan, as of December 31, 2009

In our experience, sponsors establish grace periods so participants who are automatically enrolled have the option of getting out of the plan. Of the plans that implemented automatic enrollment, most use a 30- or 31-day grace period (41%), and  20% use a grace period of 40 to 45 days.

To help participants save more over time, 57% of our clients who chose automatic enrollment also added automatic escalation. From this group of plans, 64% with automatic escalation offer the feature on an opt-in basis.

We’re seeing more sponsors choose target date investments for the default funds. Currently, 82% of our clients offer these to participants. This is compared to 8% who offer risk-based funds, 6% who offer stable value or money market and the remaining group who use balanced funds.

More on the benefits of “auto” features:

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Simplicity: A Best Practice for Retirement Plans

“Simplify, simplify.”
Henry David Thoreau, poet and philosopher (1817−1862)

We would probably do well to heed this wisdom in all aspects of life. The need to simplify can apply to retirement plans, too. Given the importance of helping participants save for a secure retirement, it may even be more critical.

We believe a sound way to simplify saving for retirement is for plans to include a suite of automatic features − automatic enrollment, escalation and rebalance. Not only can adopting the “auto-suite” simplify retirement plans, we believe these to be a best practice for plan design.

Benefits to participants
Our research shows that few participants are actively engaged in their plans. Consider this:

  • Sixty-eight percent of new participants enrolled due to a plan sponsor decision.
  • One participant in 10 made an investment transfer.1
  • Contribution levels start low and rise slowly. On average, participants reach the 10% contribution rate at age 57.

For the “accidental investor” who finds him or herself participating in the plan, the auto-suite can simplify retirement savings. It does this by leveraging inertia – participants’ inaction – and takes advantage of a common participant behavior.

Best practices for plan sponsors
Adopting the auto-suite to simplify things for participants may seem an easy choice. But does it simplify things for sponsors? We think the answer is yes − particularly when we partner with you to implement these changes. We cover the fundamentals and also consult with sponsors to help ensure key goals are addressed through plan design choices.

Our best practices:

  • Conduct automatic enrollment for current and new employees.
  • Sweep opted-out employees back through automatic enrollment every few years.
  • Set the default deferral lower so the initial contribution has less impact on take-home pay. Automatic escalation is then necessary for this to work effectively over time.
  • Use automatic escalation and require participants to opt out.
  • Set escalation at 2% increments rather than 1%, and set the cap at 10% rather than stopping at the match amount.
  • Establish a qualified default investment alternative (QDIA) and conduct a passive enrollment campaign, giving participants the opportunity to opt out.

Regulatory considerations
Understanding the regulations on automatic contribution arrangements can be daunting. Our Automatic Contribution Arrangements Comparison Chart is designed to help you navigate the requirements for − and differences between − each type of arrangement. It’s also a great tool to use when analyzing which arrangement may work best for helping employees reach their retirement goals.

Implementing auto-suite features can simplify and strengthen your plan. Contact your J.P. Morgan representative for more information.

  Source: J.P. Morgan Retirement Plan Services, 2009 Participant Data
  Source: “Ready! Fire! Aim? 2009”J.P. Morgan Asset Management


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Time for an Investment Policy Review?

Does your retirement plan now include a qualified default investment alternative (QDIA)? Does your investment policy statement reflect the QDIA and your selection process? Are there other recent plan changes that need recording?

One of the reasons for an investment policy statement is to document the prudent decision-making framework for the retirement program. It should spell out the retirement plan investments and how they are selected, monitored, measured and, when necessary, replaced.

While not a requirement under ERISA or 404(c), ERISA has indirectly imposed an investment policy statement requirement by mandating that investment fiduciaries prudently select plan investments and monitor their performance.

As a best practice, we recommend periodic review of your policy to keep it current and comprehensive. We offer an investment policy statement template, which you can use to structure your document. This recently updated template includes specific language on QDIAs and multi-asset-class investments. Contact your J.P. Morgan representative if you are interested in seeing the template.

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Decoding Target Date Fund Design
Asset Allocation

This article is the third in a series. Last month's article: Decoding Target Date Fund Design – Diversification.

How can an asset allocation strategy for a retirement plan be evaluated?

One of the biggest differentiators between professionally managed multi-asset-class portfolios – such as target date funds – is how the manager approaches asset allocation. Some differences are easily identified, such as the relative weightings of each asset class. Others are more subtle, such as the types of returns a manager hopes to achieve with a particular asset mix. Understanding how different approaches can affect performance can help you determine the allocation strategy most closely aligned to your plan’s investment goals. 

What is the manager’s fundamental approach to asset allocation?
Decision makers should understand the logic behind an allocation strategy to make sure it’s in line with their plan’s investment philosophy. For example, is the manager trying to maximize growth or minimize volatility with a particular asset mix? Are allocation decisions based on historical asset characteristics or forward-looking assumptions? These different approaches can have a significant impact on performance.

How does the manager determine each asset class weighting?
There are a range of sophisticated portfolio tools that can help guide allocation decisions. Based on our research, determining the most appropriate asset blend is ultimately linked to a manager’s ability to combine these theoretical analytics with likely real-world scenarios and investors’ risk/reward profiles.

Answering these questions can help you determine the target date investment strategy and fund managers for your specific needs.

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Inflation-sensitive Investment Strategies

Last month in Insights, we shared reasons why participants should worry about the impact of inflation on their defined contribution account balances. We outlined investment alternatives that can be used to hedge against these risks and discussed plan sponsors’ choices. This month, we provide more detail on these investment alternatives and their inflation-hedging benefits.

Stocks for the long-term – Common stock investments traditionally have served as an inflation hedge. Those who subscribe to this strategy accept the fact that inflation − in and of itself − is not necessarily bad. Low and stable levels of inflation can actually have desirable economic effects. Assuming company revenues rise proportionally with costs, stocks perform well as company profits increase. However, when the level of inflation is high or the rate of increase rapid, returns from stocks are adversely impacted. During historical periods of high inflation, equity valuations fell, as they did from 1974 to 1981, when inflation peaked at double-digit levels. High inflation erodes the present value of future cash flows, which inevitably leads to lower stock prices.    

Shorter duration fixed income – High inflation and high interest rates generally go hand in hand. Both typically lead to capital losses on fixed income assets. One way to limit such losses is to shorten the duration of fixed income holdings. 

Inflation-protected bonds – Treasury inflation protected securities (TIPS), which pay a real interest rate coupon plus an amount for actual inflation, may insulate an investment portfolio from an unexpected rise in inflation. Because the return of TIPS includes a payment for actual inflation, they can provide protection from an unexpected surprise on inflation. TIPS are fixed income investments and, while they can protect investors from nominal increases in interest rates, like all bonds their value is impacted by changes in real interest rates (the nominal interest rate less the expected inflation rate). This affects the fixed rate of interest all TIPS pay.

Commodities – Commodities, which have protected investors in times of high or rising inflation, tend to fall in value when inflation is low or declining. During the high inflation of the 1970s, gold and oil prices rose by 20% in real terms. During the disinflationary period between 1980 and 2000, they experienced declines in real terms of more than 5%. One secular trend favoring commodities is the increasing share of global growth emanating from the emerging economies of the world. Given their high economic growth rates, these countries are likely to consume commodities at a greater rate per unit of economic output than developed countries.  

Real estate – Commercial real estate assets offer long-run inflation protection in two important ways. First, the nominal replacement costs of real estate (land, labor and materials) increase with inflation over time. This provides a hedge on the value of the real estate property. Second, leasing rents are often tied to the consumer price index so the property’s income should capture any increase in inflation over time. It is important to consider the degree of property utilization as high vacancy rates increase tenant bargaining power on lease renewals.

Infrastructure – Infrastructure investments include regulated public utilities, such as water and electricity generation. These investments generally offer an “allowed return” on investment, which is designed to both deliver reasonable utility rates to the consumer, as well as cover increases in the costs of operation. This allows these investments to capture and reflect increases in the general rate of inflation in the economy.

Which strategy is right for my plan?
There is no silver bullet when it comes to protecting against future inflation. Each of these investment alternatives has a role to play in helping protect participants’ account balances from the effects of higher inflation. Importantly, each of the above alternatives is correlated to inflation in different ways and degrees. No single asset class is likely to provide inflation protection over complete market cycles.

One approach is a diversified one that combines a variety of the preceding strategies in a single multi-dimensional fund. This solution may keep the plan investment lineup simpler, while providing participants with an efficient means to protect their defined contribution assets from the effects of inflation. The investment landscape continues to evolve as inflation causes greater concern for plan sponsors. The choices available for real asset inflation hedging solutions will continue to increase.

Source: J.P. Morgan Asset Management, Insights, “From Recession Frying Pan to Inflation Fire?”
J.P. Morgan Asset Management is the marketing name for the investment management businesses of JPMorgan Chase & Co. and its affiliates worldwide. Those businesses include, but are not limited to, J.P. Morgan Investment Management Inc., JPMorgan Investment Advisors, Inc., Security Capital Research and Management Incorporated and J.P. Morgan Alternative Asset management, Inc.

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Automatic Enrollment Can Keep Things Simple

At J.P. Morgan, we advocate keeping the retirement planning process as simple as possible. One way we do this is by tailoring the communication and education experience to each participant’s time, talent and interest. Sponsors can play a role in this, too. Plan design features, like automatic enrollment, are an ideal solution for many employees, because they simplify several choices.

With automatic enrollment, employees begin participating in the plan usually after a grace period. Contributions are made at a pre-determined rate and invested in a default fund. A participant’s active decision, of course, can override any default process. Because participants are required to receive a PPA notice within 30 days of being automatically enrolled in a plan, our best practice is a 45-day opt-out period. This gives more flexibility for the sponsor because it allows us to mail the PPA notice to participants.

In our experience, the automatic enrollment process increases participation rates as well as deferral percentages. Currently, 43% of our qualified plans offer automatic enrollment (as of Dec. 31, 2009).

The Internal Revenue Service offers a variety of automatic contribution resources for plan sponsors, including:*

* Link to third-party site. Note that the third party's privacy policy and security practices may differ from J.P. Morgan's standards. J.P. Morgan assumes no responsibility for nor does it control, endorse or guarantee any aspect of your use of the linked site.

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Benefits of Auto-suite Implementation

The questions we hear from participants about automatic enrollment are typically “how” questions: How do I enroll? How are my contributions invested? How can I increase my contribution rate? How do I change my investment allocations? 

While these questions show a desire to be involved in key decisions, our experience tells us that many participants adopt a “set it and forget it” mindset about the plan. 

As of December 21, 2009, 43% of J.P. Morgan plan sponsors use automatic enrollment and 38% use automatic escalation. Sponsors seem to recognize the value of early savings and systematic processes to encourage retirement savings. Our adoption rates are consistent with industry statistics. 

The benefits of auto-suite implementation include:

  • Participants start saving for retirement in conjunction with employment through automatic enrollment.
  • Participants systematically develop good habits through automatic increase.
  • Participant investment portfolio management is simple and disciplined through automatic rebalance.

Contact your J.P. Morgan representative for detailed information on auto-suite services.

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Financial Reform and Potential Implications for Retirement Plans

The Restoring American Financial Stability Act of 2010, currently being considered in the United States Senate, contains provisions that may have a significant impact on both defined benefit and defined contribution retirement plans. The proposed legislation would appear to impose new fiduciary duties on "swap dealers" (i.e., those who act as a counterparty in a swap agreement for a fee) and would likely increase costs and complexities for issuers of stable value wrap contracts.

Sponsors of defined benefit plans routinely use derivatives to manage volatility within a plan's portfolio. In addition, the definition of a derivative appears broad enough so that a wrap agreement issued in connection with stable value funds may be treated as a derivative. There is concern that the proposed legislation, as it currently stands, would create a fiduciary duty for swap dealers based solely on their intent to enter into a derivative contract with a retirement plan. This places the dealer on both sides of the transaction (having a fiduciary duty to the plan) and representing itself and its shareholders as the seller. This is a scenario that would appear to violate ERISA's prohibited transaction rules, as well as other laws governing fiduciary conduct.

Impact to qualified plans
Under this interpretation, a defined benefit plan and its plan sponsor would effectively lose a valuable tool to control market and interest rate risk and would see their funding volatility increase. For defined contribution plans, stable value funds might be unable to enter into wrap contracts on a go-forward basis. Issuers of existing contracts might be subject to new margin, capital, reporting and clearing requirements. This could possibly limit the use of these funds as an investment option for plans and deny participants a popular choice for minimizing the risk to their principal.

Senators Tom Harkin (D-IA) and Bob Casey (D-PA) had proposed an amendment that would provide clarity on the swap dealers’ duties and alleviate some industry concerns. Under their amendment, swap dealers would not be a fiduciary merely by reason of offering to engage in a derivatives transaction with a plan. Instead, swap dealers would be subject to a duty of fair dealing and would be prohibited from engaging in fraudulent actions. Unfortunately, that amendment was not part of the final version of the bill that passed on May 20, 2010.

Next step for legislators
The next step in the legislative process will be a conference committee to reconcile the Senate bill with the House version of financial reform that passed late last year. The House version of financial reform did not include the provisions regarding fiduciary duty that have been the cause of concern in the retirement industry. Both the Senate and House will appoint their conferees in the upcoming days, and it is anticipated the reconciliation will be completed by mid-June.

This has been a rapidly changing situation, and we will continue to monitor developments and remain actively engaged as things progress. As always, we will keep our clients informed.

Note: A derivative is a financial instrument, the price of which is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties, the value of which is determined by fluctuations in the underlying asset. Swaps are a type of derivative.

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IRS Questionnaire for Plan Sponsors

The Internal Revenue Service (IRS) is conducting an online survey of 1,200 different 401(k) plan sponsors randomly selected from those who completed a Form 5500 for the 2007 plan year. Sponsors are being asked to complete a 40+-page questionnaire that is essentially a compliance check. While this is not an audit or investigation, failure to fill out and provide complete information will result in enforcement action, which could include a plan audit by the IRS.

The questionnaire, which focuses on the 2006, 2007 and 2008 plan years, covers a wide range of topics, including:

  • demographics
  • plan participation
  • automatic contribution arrangements
  • employer and employee contributions
  • plan compensation
  • nondiscrimination rules
  • distributions and loans
  • plan operations and administration
  • Roth features
  • IRS voluntary compliance programs

The questionnaire asks for very specific information in many cases. While this is intended to be a compliance check, there is at least one question that asks for the plan sponsor’s opinion on how much impact different factors have on plan participation (such as age, compensation level, matching contributions, access to funds, etc.). It is not clear how this information will be used. Regarding contributions, the questionnaire asks if there was a reduction, suspension or discontinuance of employer contributions during the 2006 to 2009 plan years.

The IRS will publish the resulting information in a report identifying areas where more focused guidance, education and outreach is needed and describing how the IRS can use enforcement efforts to address noncompliance.

The IRS will contact selected plan sponsors by mail with instructions on how to complete the questionnaire. View a copy of the questionnaire.

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Biggest Saver Logo

New from The Way Forward –
“The Biggest Saver” and “Think twice before borrowing”

For years, our Retire on Track newsletter provided regular tips to participants on how to more effectively use the retirement program to reach their retirement dreams. Last month, we retired the newsletter and replaced it with a new video series, “The Biggest Saver,” which can be found on The Way Forward site.

In this “reality-show” series, watch six “contestants” vie for the title of The Biggest Saver. In each monthly episode, contestants compete in a series of challenges tied to these “Tips to Retire on Track:”

  • Am I participating in my retirement plan?
  • Am I taking advantage of my plan match?
  • Am I saving enough?
  • Am I a long-term investor?
  • Am I adequately diversified?
  • Am I avoiding frequent trades?
  • Am I letting my investments grow?

The May episode focused on avoiding frequent trades. The June episode emphasizes letting your investments grow by avoiding plan loans.

Encourage your employees to pop some popcorn, tune in and find out who will be The Biggest Saver.

Think twice before borrowing
July brings The Way Forward’s third Webcast of the year, “Think twice before borrowing,” which focuses on the consequences of 401(k) loans. We also investigate alternatives and how your employees may position themselves financially to help avoid borrowing. How to join July Webcast.

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“What’s Next for Small Caps?” Webcast Replay

If you missed the May 25, 2010, Webcast featuring Kimberley West, J.P. Morgan Asset Management client portfolio manager, on the role of small caps in defined contribution plans, you can listen to the recorded version. The Webcast explored small cap investing and the current market environment; the outlook for the asset class; the risk/return profile; and the role of this asset class in a defined contribution plan.

You can listen to the Webcast replay, or click the URL below. When prompted, enter your name, recording ID and key. 

Recording URL: https://www.livemeeting.com/cc/emeetingplace/view  

Recording ID: SCaps
Recording Key: 309497  

This recording will be viewable for 60 days.

Understanding that the regulations governing automatic contribution arrangements can be daunting, this chart is designed to help you navigate the requirements for, and the differences between, each type of arrangement. It is also a great tool to use when analyzing which arrangement works best for helping your employees reach their retirement goals.

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Market Pulse

Resources from J.P. Morgan Asset Management:

Stu Schweitzer

Stu Schweitzer, Global Markets Strategist

  • MacroMinute Weekly, a two- to three-minute audio commentary from J.P. Morgan's Global Markets Strategist Stu Schweitzer summarizing insights and outlook on the economy, financial markets and asset allocation. MacroMinute Weekly can be delivered to your mobile or office phone on Monday mornings before the start of the business day. To subscribe, e-mail Retirement_Insights@JPMorgan.com and include your name, firm name and phone number.
  • Guide to the Markets, a quarterly publication featuring the latest economic, market and demographic information across a wide range of asset classes including equity, fixed income, international, real estate, retirement and alternatives.
  • Market video replays, a timely series of videos featuring Dr. David Kelly, J.P. Morgan Funds’ Chief Market Strategist, and our portfolio managers and market specialists sharing their views and analysis of key market and economic trends.

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In the News

Find news and information about JPMorgan Chase & Co. on our corporate Web site.

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Contact us at: Retirement_Insights@JPMorgan.com

For questions about your personal retirement plan, contact J.P. Morgan Retirement Plan Services at 800-345-2345 or call your retirement plan provider.

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Availability of products and services featured in Insights vary by plan. For details, contact your J.P. Morgan representative.

This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice.

Certain underlying Funds of the Target Date Funds may have unique risks associated with investments in foreign/emerging market securities, and/or fixed income instruments.  International investing involves increased risk and volatility due to currency exchange rate changes, political, social or economic instability, and accounting or other financial standards differences.  Fixed income securities generally decline in price when interest rates rise.  Real estate funds may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector, including but not limited to, declines in the value of real estate, risk related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by the borrower.  The fund may invest in futures contracts and other derivatives.  This may make the Fund more volatile.  The gross expense ratio of the fund includes the estimated fees and expenses of the underlying funds.  A fund of funds is normally best suited for long-term investors.

J.P. Morgan Institutional Investments Inc. (JPMII) has hired Financial Engines Advisors L.L.C. (“FEA”) to provide sub-advisory services. JPMII is a federally registered investment advisor. FEA, a federally registered investment advisor and wholly owned subsidiary of Financial Engines Inc., is an independent company that is not affiliated with J.P. Morgan Retirement Plan Services LLC or JPMII. Neither JPMII, FEA, nor its affiliates guarantee future results. Financial Engines® is a registered trademark of Financial Engines, Inc. All other marks are the exclusive property of their respective owners. ©2005-2010 Financial Engines, Inc. All rights reserved. Used with permission. J. P. Morgan Retirement Plan Services provides plan recordkeeping and administrative services.

J.P. Morgan Asset Management is the marketing name for the investment management businesses of JPMorgan Chase & Co. and its affiliates worldwide. Those businesses include, but are not limited to, J.P. Morgan Investment Management Inc., JPMorgan Investment Advisors, Inc., Security Capital Research and Management Incorporated and J.P. Morgan Alternative Asset management, Inc.

All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. They are based on market conditions at time of the analysis and are subject to change.  Results shown are not meant to be representative of actual investment results. Past performance is not a guarantee of and may not be indicative of future results.

Publications referenced in this material are presented for general educational purposes only. JPMorgan and its affiliates did not receive any compensation or consideration  for referencing these titles. The opinions and information presented in these titles do not necessarily reflect the opinions of JPMorgan Chase & Co. and its affiliates.

Diversification does not assure a profit nor does it protect against loss of principal. Diversification among investment options and asset classes may help to reduce overall volatility.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

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