Tailored to Fit
Featured interview is with John LaCara, Director, DC Plans Commonwealth of Massachusetts
Moderated by: Stacy Schaus, CFP®, PIMCO Senior Vice President and Defined Contribution Strategist
We talk with John LaCara, director of the Commonwealth of Massachusetts deferred compensation plan. John shares with us the structure of their 457 and other retirement plans. He discusses why and how they tailored target-date strategies to their demographics. He also notes the importance of their defined contribution plan in creating sufficient retirement savings.
DC Dialogue: John, thank you for joining us. We're very interested in hearing about the DC plan offered by the Commonwealth of Massachusetts. Please tell us a bit about it and the people it serves.
LaCara: It's a retirement savings program authorized under Section 457 of the Internal Revenue Code and Massachusetts General Laws. The plan has approximately 91,000 full-time participants and 182,000 part-time participants with total assets of $4.3 billion. It allows eligible employees to save money for retirement on a pre-tax basis through salary deferrals with their employers. It's available to employees of the Commonwealth of Massachusetts or any governmental body, such as cities and towns. Over 600 non-state entities participate in the plan.
Participants include public safety officers, elected officials, public university professors and administrators, and municipal employees. Many participants also belong to a defined benefit plan, and some can join other DC plans such as a 403(b).
DCD: There's a reasonably diverse group of individuals with different educational backgrounds in this plan. But it also sounds like this DC plan is not necessarily the primary retirement savings vehicle.
LaCara: The DC plan supplements our DB program. The plan's central function is to offer a broad array of quality investment options, minimize participant administrative and investment costs, and help employees save and invest for retirement. Because it's an unbundled plan - and can leverage investment relationships within our DB plan - we're able to offer institutionally priced investment vehicles.
DCD: We see many private employers bring in auto-enrollment programs, as well as contribution escalation and target-date strategies. Do you offer these as well?
LaCara: We offer an auto-rebalance program, and we intend to implement an auto-enrollment program in the future - most likely using our new target-date strategies as the default option.
DCD: Auto-enrollment is a newer concept for public plans. How did you become interested in this approach?
LaCara: Governmental plans generally have a lower participation rate than private-sector plans - mainly because most government plans don't match participant contributions. Nonetheless, we do want to make people aware that savings are important and that future retirement income from other sources may be insufficient to meet retirement needs.
It's very important that people also save in their 457 plans. We hope that, once we implement auto-enrollment, we'll be able to create some positive inertia and increase awareness.
DCD: What are some of the primary differences between a 457 plan and a regular 401(k)?
LaCara: The main difference, from a tax perspective, is that a 457 plan isn't subject to the 10-percent premature withdrawal penalty that you face with a 401(k). However, unlike a 401(k), you must leave your money in a 457 plan unless you separate from service or retire. Money access is different.
DCD: Otherwise, a 457 can roll over to an IRA. When the money is within a 457, it works in a manner similar to the 401(k), correct?
LaCara: That's right. It's just as portable as a 401(k) because we can accept 401(k) and IRA rollovers, as with similar plans.
DCD: You try to get people to save more for retirement, and view the 457 as an effective way to help people do that, using a DC-type plan. What are some differences in how you manage your DC plan, compared to how a private employer manages its plan?
LaCara: Private-sector DC plans increasingly are becoming, or have become, the primary savings vehicle and retirement income source for private-sector employees. With this transfer of risk and responsibility from employer to employee, the risks are viewed differently. For example, we need to look at shortfall risk differently if DB payments no longer serve as retirement replacement income. This may impact policies pertaining to compensation and benefits, such as the appropriate level of employee matching. However, we haven't seen a vast migration from DB to DC occur in the public sector. DB payments still serve as the primary source of retirement income and affect how we view risk factors.
Overall, there aren't many differences. We're both working toward the same goal: providing a quality retirement plan at minimal cost.
DCD: In the private space, as DC plans become the primary retirement savings source, sponsors increasingly are adding target-date strategies to their plans. Have you introduced target-date strategies as well?
LaCara: Yes. In July, we launched our custom target-date strategies. Prior to this, the plan offered three risk-based lifestyle funds - conservative, moderate and aggressive - with static asset allocations among four asset classes. These risk-based funds represented just 6 percent of total plan assets.
We decided to create target dates to allow for broader asset diversification and to simplify the fund-selection process. By leveraging existing relationships with investment managers, we built the target-date funds using institutionally priced investment funds. The approach also allows us to maintain control of the underlying investments and tailor the glide path to plan demographics.
DCD: How is a tailored approach to target-date strategies different from a packaged product?
LaCara: A prepackaged mutual-fund product, for example, doesn't consider a specific DB payment in retirement. We wanted to account for this benefit in the glide path. Also, while state employees tend to have greater employment certainty, their wage levels tend to be lower. So employment risk and wage-level assumptions are different.
We couldn't control a retail, prepackaged target date's assumptions. But by providing our demographics to a glide-path or lifecycle manager, the manager can use that information to build a glide path tailored to our demographic base.
With that in mind, custom strategies aren't a panacea. Managed accounts may be more effective on an individual basis.
Target-date strategies are tailored to individuals who don't have the time, desire or experience to develop their own portfolios. The strategies are for people who want to put their money away, not worry about it, know that professionals are managing it, and then revisit it, perhaps once a year or each quarter.
DCD: You have a DB plan, greater income certainty, and a lower wage base. So, are your custom strategies more, or less, aggressive in their allocations to different asset classes than the allocations of typical packaged target-date products?
LaCara: The combined factors determined the ultimate glide path. Our glide path starts at 95 percent equity, which is probably a little more aggressive than typical prepackaged products.
DCD: What is the glide-path composition at retirement age?
LaCara: Sixty percent equity. However, the glide path isn't just for the accumulation phase. It's also for the retirement phase - when shortfall risk becomes a factor. We need to manage this DC money throughout a participant's lifetime, not just to the point when they stop working.
DCD: You have relationships with different investment managers. What types of investment strategies do you have in your lineup?
LaCara: We wanted to use our own investment managers because we believe our plan offers a best-of-breed lineup. We also have very advantageous pricing, and a good mix of passively and actively managed funds.
The target-date funds' asset allocations consist of eight investments from our lineup, including domestic large-cap equity, domestic small-cap equity, international equity, domestic bond, REIT, high-yield debt, TIPS, and money market. Of these, the REIT and high-yield funds are actively managed.
DCD: How did you decide on the REIT, TIPS and high-yield asset classes?
LaCara: We added them to the plan to give participants access to additional asset classes and the ability to further diversify their portfolios. As part of the target-date strategies, the asset classes provide the same diversification and inflation-protection benefits.
DCD: Makes sense. How did you design your initial glide-path structure?
LaCara: We issued a request for proposal because we wanted to hire a lifecycle manager to design it for us. We required the lifecycle manager to act as investment manager and fiduciary. We interviewed firms and provided them with our plan demographics. Using some of the information discussed earlier, the candidate proposed a tailored glide path for us.
DCD: As you looked at the various firms that provide glide-path oversight, did you seek a glide-path manager for its expertise, or was it legally necessary to have one?
LaCara: It was based on policy. We needed somebody to act as an investment manager and fiduciary. When we compared firms, we considered depth of research and track record at providing similar services for other entities. The ability to provide assistance with marketing and communications was also a major factor.
DCD: Many companies are interested in setting up custom strategies. However, we often hear the common concerns, "We don't have an extensive staff and it's just too much work." How large is your staff and how much work was it to set up the strategies?
LaCara: We don't have an extensive staff either. Our department consists of two people. But we used a consultant to help us search for vendors.
We did a lot of planning for the custom strategies before we issued the RFP. We verified that our custodian was capable of striking a daily net asset value for these types of strategies, and confirmed that the record keeper could add the funds to their systems and accept and process the trades.
We also notified the investment managers of our intention to add these to our plans and that it would alter trading activity in the managers' funds.
DCD: Depending on how a company's record-keeping system works, some establish custom strategies within the system, while others use an outside trust company to establish a trust with the assets. Which approach did you take?
LaCara: We only had to add the new target-date funds' names to the system. Essentially, we reengineered the risk-based funds into a target-date series and added assets classes to the lineup. Once we'd established the new target-date strategies, we mapped participants' assets from the risk-based funds into one of 11 target-date vintages based on participant age.
DCD: How extensively did you discuss how to best map participants to the new strategies?
LaCara: Marketing for the new target-date strategies focused on participant age when selecting a fund. We used the same methodology for the mapping process.
DCD: Returning to operations, did you have any funding issues? Did you require an asset-level threshold before you could get each of the 11 strategies off the ground?
LaCara: We use existing manager relationships and mapped assets from the risk-based funds, so it wasn't an issue.
DCD: Do you provide the matrix, or glide-path asset allocations by age, to the record keeper, and then it implements the matrix directly into the system?
LaCara: That's right. We provide to the record keeper the asset allocation for each fund. The record keeper mapped each participant's risk-based portfolio into a specific fund based on participant age.
DCD: How does that work on an ongoing basis with your outside glide-path investment manager? How often does the manager provide instructions to shift the balance?
LaCara: We meet with the lifecycle manager periodically to review the glide path and performance, as well as the assumptions used to determine the glide path. The glide-path manager provides the record keeper with the asset allocations for each quarter.
DCD: You mentioned that a managed-account program may be even a better approach than target-date strategies. Should sponsors offer managed-account advice or other services and tools in addition to the strategies?
LaCara: Absolutely. Multiple solutions can help when you're trying to meet the demands of various investor behaviors. We offer free asset-allocation services, both one-on-one and in seminars. People can do the same thing online. Complete a risk-profile questionnaire, and the system generates a recommended portfolio. If a participant wants a more comprehensive financial plan, we also offer a "for-a-fee" service. The participant meets with a financial planner who looks at all retirement assets and develops a financial plan.
DCD: Where do you find people who offer that service?
LaCara: Our third-party administration and record-keeping agreement provides advice services. We try to issue an RFP for these services every three to five years, at least.
DCD: Sounds great. On the communication front, you said creating information about your new target-date strategies is complicated. How do you look at broader communication issues?
LaCara: We also developed a new marketing campaign to accompany the launch of the target-date strategies. The basic premise is that participants now have two paths to investing for retirement. Path 1 is to select a target-date portfolio based on age. Path 2 tells them how, with assistance, to build and monitor a personal portfolio. We wanted to contrast the differences between the ease of selecting a target-date portfolio and the effort required to do it yourself.
DCD: How do plan participants compare information about the 11 target strategies you offer?
LaCara: We developed fact sheets for each investment and strategy in our plan, so people can compare them easily. Our record-keeper/third-party administrator creates them, in conjunction with the lifecycle manager. Our field representatives distribute the fact sheets, which also are available online.
DCD: Your plan participants have an apples-to-apples information sheet that your record-keeper updates automatically. After it's set up initially, do you still need to be involved?
LaCara: Yes. Whenever it requires a revision. We review each quarterly update.
DCD: Now that your strategies are up and running, how much ongoing effort does your custom approach require?
LaCara: We like the custom approach because due-diligence and oversight support requirements aren't extensive. Due diligence on the underlying investment managers is the same as it was prior to offering the strategies. The only additional component is supervising the relationship with the glide-path manager, the only new vendor in the process.
The beauty of customizing your own strategies is not wearing yourself thin by adding, say, a target-date fund series with seven underlying funds not offered in your core lineup. That would require far more work.
DCD: So your core, DC-option, due-diligence process remains in place. Do you use many of the same managers in the DB plan as the DC plan?
LaCara: Yes. We try to leverage relationships as much as possible.
DCD: Are you considering introducing other assets classes from your DB plan into the DC plan?
LaCara: Not at this time. We already offer REITs, TIPS and high yield. If you'rereferring to, say, alternative investments or commodities, I'm not sure if we'd add those to the DC plan as stand-alone investment choices. However, down the road, you never know. They might be a good addition to the target-date funds' asset allocations.
DCD: You use all institutional strategies. Have you calculated the all-in cost to offer this type of a solution?
LaCara: Our all-in cost is under 25 basis points. In some cases, compared to the retail sector, our costs are three to four times lower than prepackaged products.
DCD: Do you have advice for other plan sponsors as they consider creating custom strategies? Would you do anything differently?
LaCara: We wouldn't have done anything differently. It worked out very well. We came up with a great offering in the end. In fact, the target-date strategies are even more successful than I anticipated. To make it a successful endeavor it's very important to coordinate with the various vendors.
DCD: Are your participants happy with the offering?
LaCara: I think so. They seem attracted to the idea that it's a simple solution to making investment choices.
DCD: Why might a public plan be more interested than a private plan in creating its own asset mix?
LaCara: The plan can take into consideration the unique aspects of its demographics, such as a DB component. Another reason is to leverage existing relationships. Whether it's public or private, the plan likely has the same desire to use best-of-breed investment managers and to lower plan costs.
DCD: Can smaller companies implement the plan you describe?
LaCara: Smaller plans can do it - especially if they have an existing DB relationship.
DCD: Do you unitize your assets with the DB plan?
LaCara: No. But we aren't prevented from using the same managers or vendor.
DCD: Thank you, John, for sharing so much about your programs.
LaCara: My pleasure. Thank you.
About the PIMCO DC Practice
PIMCO DC Dialogue is prepared and distributed by the PIMCO DC Practice.
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