Spring/Summer 2017

United Technologies: Inside one of the most innovative plans in the US

DC MattersInvestment cornerCore plus fixed income Page 18

Participant communicationsThe language of fees Page 24

An academic angleShark attacks?Page 30

Walter Bibikow/The Image Bank/Getty Images

Creating communications that resonate with participants (and that they’ll actually read) is one of the many challenges facing plan sponsors. And the words you use are critical.

Welcome to the latest publication of DC Matters, a two-time STAR Award1 winner for its innovations in retirement thought leadership. Each issue contains insights and ideas we hope you find helpful in your role as a plan sponsor. Our contributors all have one thing in common; they share your passion for helping American workers achieve their goal of a secure and comfortable retirement.

Helping workers make better choicesThe field of behavioral finance examines how emotional, social and cognitive factors influence our decision-making and savings behavior. Traditional retirement plan design and communications are too often based on assumptions — people don’t always approach retirement decisions in a rational way that reflects their best interests.

Insights into investor behavior have helped influence innovations in plan design such as using opt-out versus opt-in features, limiting investment choices and providing access to financial advice. The growth in adoption of auto features, white labeling and smaller but more diverse investment menus are also positive steps.

As guest author Raphael Schoenle addresses in his article, “Shark attacks?,” even such factors as how long we think we’ll live can influence savings and spending behavior.

The work done by United Technologies Corporation (UTC), also featured in this issue, is a great example of how a firm can enthusiastically embrace aspects of behavioral finance to help boost retirement savings and offer a robust income solution. UTC believes that helping employees accumulate savings — but cutting them loose post-retirement — is like abandoning them halfway through their journey.

Words matterCreating communications that resonate with participants (and that they’ll actually read) is one of the biggest challenges facing plan sponsors. We have found that word choice is critical.

Our extensive financial language research shows that employees prefer personalized communications in plain English, using positive, hopeful messages that address the potential benefits of investing for retirement. They don’t respond as well to fear- or guilt-based messages that attempt to shame people into investing. As you’ll read in “The language of fees” article, even the term “fees” can evoke a strong negative reaction.

This publication is designed for you, and we hope you find it to be a valuable resource. We welcome your thoughts, feedback and suggestions for future topics. I encourage you to contact your Invesco representative or email our DC Matters editorial staff at DCMatters@invesco.com.

Regards,

Marty Flanagan, President and CEO Invesco

Marty Flanagan at a recent client event in Hong Kong

1 2015 and 2016 Mutual Fund Education Alliance STAR Award for Thought Leadership/White Papers in the Retirement Category for the Large Plus Asset Level. The STAR judging system features key criteria that measure the elements of design, usability, content/message and educational value. Judging is performed by leading fund industry executives in marketing, communication and design.

Louise Murray/MediaBakery.com

DC Matters Spring/Summer 2017 1

DC digestWhite label approaches

Setting the stage Page 2

Food for thought Advice in a digital age

Will robos invade your DC plan? Page 4

Facts and figuresDC trends

Page 5

Plan sponsor forumUnited Technologies Corporation

No stone unturned Page 6

Hail to the chief (economist)Global economic outlook

Is the Trump ‘reflation trade’ losing momentum? Page 12

Investment cornerCore plus fixed income

Is your fixed income under-diversified? Page 18

Participant communicationsThe language of fees

The numbers won’t speak for themselves Page 24

What’s up on Capitol Hill?Legislative insights

The time may be near for comprehensive US tax reform Page 26

An academic angleShark attacks

How distorted mortality beliefs impact savings behavior

Read the full story on Page 30

Nuts & boltsAllocating fees

Which methodology is best for your plan? Page 36

Table of contents

Invesco’s official magazine for defined contribution plan sponsors

2

DC digestWhite label approaches

Greg Jenkins, CFAHead of Institutional Defined ContributionInvesco

Greg Jenkins has more than 20 years of experience working in the DC industry. He’s a frequent speaker at industry conferences and webinar events, sharing his passion for educating plan sponsors and their participants. Mr. Jenkins earned a BA degree in economics from the University of Colorado and an MBA from the University of Texas at Dallas. He is a CFA® charterholder and an active member of DCIIA, NAGDCA, Southwest Benefits Association and the Dallas Society of Financial Analysts.

The practice of “white labeling” refers to combining multiple managers or strategies into broad investment options that are generically labeled. This allows plan sponsors to simplify the investment choices for participants.

In prior issues of DC Matters, I have written about the benefits of white labeling: • The ability to blend active and passive

management• Leveraging the expertise of existing

defined benefit (DB) managers• Limiting and simplifying investment

options without sacrificing diversification• Removing brand bias and name

confusion• Potentially lowering expenses

White label investments in DC plans are not a new phenomenon. Large DC plans have used them for many years, and until recently, the primary focus was on the mechanics. Now that white labeling is more common, many of the operational difficulties have been addressed. There are also consultants, asset managers and recordkeepers who can help with pieces of the puzzle.

Beyond the operational aspects, there are more important questions for plan sponsors to consider:• Should the options be organized by

objective or asset class?• What are the appropriate risk targets?• Do we re-enroll participants or map

assets from existing investment options? • What do we name them?

These questions, and many more, fall under two key areas that are critically important for plan sponsors to consider — strategy and communications.

StrategyWhen planning a transition to white labeling, it’s important for a committee to develop a high-level set of goals for the core investment menu. Before this discussion can begin, leverage data from the plan’s recordkeeper. Some of the key data points should include:• Percentage of plan assets residing in

the core menu• Investment concentrations• Average levels of risk and expense

experienced by different groups• Demographic patterns

Setting the stage

Following the long-awaited publication of the Department of Labor’s tips for target date fund fiduciaries in 2013, the core investment menu seemed to fall off the radar for many plan committees. But even with the remarkable growth in target date funds since then, the core menu is still home to 66% of plan assets.1

DC Matters Spring/Summer 2017 3

Read Greg’s blog at blog.invesco.us.com

1 Source: Callan Associates, The Callan DC Index, 4th quarter 2016

Invesco Consulting’s New Word Order program is based on our firm’s ongoing financial language research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners.

Once the data have been collected and analyzed, the committee can begin to formulate a strategy for the white label options. For example, some plan sponsors have expense reduction as their number one goal, while others are focused on reducing the number of investment options.

The next big decision is whether to pursue an asset-class approach or one that is more objective-based.

Another important consideration is the existence of a DB plan. This may alter the risk level that you target in the core menu. For example, since a pension benefit behaves much like fixed income in a participant's overall portfolio, it might make sense to target a higher risk level in the core menu equity options. Another factor is employee demographics.

Lastly, plan sponsors may consider outsourcing the white label options to a 3(38) fiduciary. This is becoming more common and it may ease the complexity — but not remove — the governance required on the investment options. There are consultants and outsourcing specialist firms that are willing to take on this role.

CommunicationsWhen introducing white label funds, participant communication is critical. All of the work and good intentions may be completely misunderstood by participants if the rollout isn’t communicated thoughtfully without understanding the advantages,

participants may become less engaged because they don’t recognize the names of the funds.

Invesco’s ongoing financial language research — which encompasses more than 50 focus group sessions and several national surveys — shows that participants are deeply skeptical of “new” plan features. And who can blame them? When it comes to employer benefits, participants tend to associate the word “new” with adverse changes.

Based on our research, there are three steps to successfully introducing white label options:1. Acknowledge participant goals and

how the new options can help meet them.

2. Explain why the investment menu is changing and the benefits.

3. Provide a straightforward summary of the fees.

Our research has also found that it’s important to relate a new investment to one that is already known and has a more established level of familiarity. For example, explain to participants that white label options operate in a similar way as mutual funds.

Investments costs should be crystal clear. If there’s a reduction in expenses, it’s important for sponsors to highlight that benefit. Surprisingly, our focus group participants indicated that unexpected or

unexplained fees were even less desirable than underperformance.

Terms that didn't resonate with participants in our studies include highlighting “institutional quality” or “best in class” managers. Finally, to make sure your communications hit the mark, consider holding your own participant focus groups to explore these issues. Plan sponsors like the City of Los Angeles — featured in a previous issue of this publication — have been conducting focus groups for years, gathering valuable information along the way.

Focus group participants indicated that unexpected or unexplained fees were even less desirable than underperformance.

Bottom lineSimplifying your investment menu, improving diversification and lowering costs for participants are noble pursuits. However, understand that the decisions and planning involved with implementing white label funds take time. Even if you are only exploring the possibility for your plan, it’s worthwhile to begin talking with your committee about some of the high-level considerations. There are plenty of expert partners who can help you along the way including consultants, recordkeepers, asset managers and custodians.

Two approaches to white label funds

Asset class based Objective based

US equity large company

US equity small/mid cap Growth

International/global equity

US fixed incomeIncome

Global fixed income

Real estate/real assets Inflation protection

Stable value Capital preservation

For illustrative purposes only

4

Food for thoughtAdvice in a digital age

Read Jeff’s blog at blog.invesco.us.com

Jeffrey Hemker National Sales Manager, Retirement Division Invesco

With more than 30 years of experience in the industry, Jeff Hemker has been a featured speaker at educational seminars and industry events throughout his career. He is a frequent blogger and shares his passion for helping improve participant retirement readiness. Mr. Hemker graduated from the University of Wisconsin-La Crosse and Roosevelt University. He is a Certified Investment Management AnalystSM (CIMA®) professional.

The term “robo-advisor” is used to describe a wide range of digital advice and technology solutions. But while robos have been touted as the wave of the future, there’s no denying that retirement investors still see value in the expert advice of human advisors. There may be potential benefits for DC plans to adopt digital technology — the key for consultants and sponsors is to determine the right balance between robo efficiency and human expertise.

Digital advice is becoming more popular with retail investors. But is it right for your retirement plan?

Location, location, locationThe days of getting plan participants together for a meeting in the lunch room are over. More employees work from home or are scattered across multiple offices and remote locations. Robo technology may offer additional ways for advisors to service DC plan participants by broadening their reach in a scalable manner. An advisor may not have the capacity to personally visit with 500 people, but 500 people can certainly access a digital platform from their home or work computer.

Delivering holistic adviceDigital platforms can offer automated account aggregation, meaning they can collect participants’ information on financial assets outside the plan (if participants choose to provide that information). Having access to that level of detail enables robos to provide holistic “advice” on a mass scale. For participants with small balances who typically don’t have access to an advisor, this technology can be a good way to get guidance on their portfolios.

Custom portfolios unique to each individualDigital technology may offer more personalized asset allocation models than the usual off-the-shelf versions. Advisors can oversee and place parameters on the fund selection, with the robo generating the final output. The robo would simply take all of a participant’s information, run it through the system, and design an asset allocation model based upon where they’re already invested, their current assets and where they are in their lifecycle. We currently see similar solutions provided by managed account providers, but robo platforms could even utilize funds outside the core lineup.

The value of human relationshipsWhile digital solutions can play a valuable role in automating and simplifying various elements of the investment process for participants, human relationships are still key. Though younger generations

have a higher preference for technology solutions, investing for retirement can be an emotional task, and many investors may not be willing to hand over their nest eggs to a “robot.” Digital technology can help advisors spend more time focusing on higher value-added services and plan design.

Bottom lineAs robo advice takes further hold in the retail market, we may see spillover into the DC plan market within the next few years. Robo advice is certainly better than getting no advice at all. It’s not widely seen as a replacement, but rather a complement to human expertise.

Will robos invade your DC plan?

1 Source: Invesco Consulting, “The Language of Change,” based on our firm’s ongoing research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners.

How do investors feel about digital advice services?In a 2016 study, we found that investors — who prefer to work with advisors — were not fond of working with robots. However, when they understood these platforms were designed to assist advisors and help them work better as a team, many investors not only liked the idea, but were also willing to pay more for the service.

Thinking about technology that your advisor can use to help manage your account, which of the following would you most want?1

%

• Advisor-assisted technology 30

• Investor-focused digital strategies 26

• Enhanced advisor technology 25

• Automated investing technology 11

• Digital advisor platform 6

• Robo advisor 3

What we learnedAvoid talking about digital services as autonomous robots. Instead, talk about advisor assisted technology that “helps us make better financial decisions together.”

DC Matters Spring/Summer 2017 5

Facts and figuresDC trends

For more information, visit invesco.com/dc

Generation app2

Fate worse than death1

60% of baby boomers are more afraid of running out of money than dying.

57% of millennials consider the ability to manage their retirement plan account via a mobile app “very important” or “extremely important,” versus just 26% of baby boomers.

26% boomers

57%millennials

How much do pre-retirees think they’ll need to save for retirement?3

47%of pre-retirees are not sure how much monthly income they will need in retirement.3

54%

22%

24%

%• No idea 54• Less than $1 million 24• Over $1 million 22

“If you don’t know where you’re going, you might not get there.”

—Yogi Berra

Pre-retirees need answers3

10 best states for retirement4

1. Florida 2. Wyoming 3. South Dakota 4. Iowa 5. Colorado6. Idaho 7. South Carolina 8. Nevada 9. Delaware 10. Wisconsin

Rankings based on affordability, health-related factors and overall quality of life.

74% of pre-retirees agree that they should be doing more to prepare for retirement.

Four in 10 say they simply don’t know what to do.

Income assistance5 50% of large plan sponsors offer some form of retirement income solution(s)

27.4%

14.2%

12.3%

3.8%

3.8%

1.9%Longevity insurance/QLAC

In-plan guaranteed income for life product

Annuity placement services

Annuity as a form of distribution payment

MA/income drawdown modeling services

Access to DB plan

1 Source: Fox Business, “Older Americans are more afraid of running out of money than death,” Sept. 25, 20162 Source: Corporate Insight, 2016 DC Plan Participant Survey3 Source: PGIM, 2016 Retirement Preparedness Survey Findings4 Source: WalletHub, 2017’s Best & Worst States to Retire5 Source: Callan Institute, 2017 Defined Contribution Trends SurveyMA = Managed accounts

6

DC Matters Spring/Summer 2017 7

Plan sponsor forumUnited Technologies Corporation

TDFs = Target date funds

Automatic features

Kevin T. Hanney, CFA Senior Director, Pension InvestmentsUnited Technologies Corporation

Kevin T. Hanney, CFA, is a Senior Director of Pension Investments for United Technologies Corporation (UTC) where he holds responsibility for oversight of the firm’s non-US defined benefit and US-based defined contribution plans. Kevin holds the Chartered Financial Analyst designation and previously worked in various roles in the asset management industry, moving into the capacity of plan sponsor in 2000. He was recognized in 2012 through the inaugural Innovator Awards sponsored by Pensions & Investments magazine and the Defined Contribution Institutional Investment Association for his role in designing the Lifetime Income Strategy, a game-changing retirement savings and guaranteed income program available to participants in the UTC Employee Savings Plan. Mr. Hanney was also recognized by Institutional Investor as the winner of their 2015 Investor Intelligence Award for Defined Contribution and served as a member of the U.S. Department of Labor’s ERISA Advisory Council from 2014 through 2016. He has been an active professional within the global investment community since 1993.

First, discuss the overall philosophy and core mission behind UTC’s DC plan?One of the primary objectives of the UTC Employee Savings Plan is to offer our participants the opportunity to secure their retirement income through the plan. We do that with our qualified default investment alternative (QDIA), the Lifetime Income Strategy. By automatically enrolling participants in the strategy, participants gain access to a secure stream of lifetime income in retirement.

Other objectives for the plan include providing a simplified investment choice architecture and emphasize automatic plan features to help participants build their savings and future retirement income.

We made a conscious decision to close our traditional DB plan to new hires after 2009. With that decision, it was important for us to make sure that the DC plan provided access to some form of retirement income security, while preserving freedom and flexibility for participants to adapt as needed.

No stone unturnedUnited Technology Corporation’s DC plan is approaching its 40th anniversary with more than 111,000 participants. But UTC is not content with its innovative Lifetime Income Strategy, its automatic enrollment and escalation features, or its clear, plain language approach to labeling its funds. Rather, they are constantly looking for ways to further refine and improve the plan’s features, communications and investment choices. DC Matters interviewed Kevin Hanney, Senior Director of Pension Investments for the plan, about the present successes of the plan, as well as his vision for the future.

Custom TDFs

Lifetime Income Strategy

Generic labeling

8

Plan sponsor forumUnited Technologies Corporation Continued

However, we were already working on this enhancement to our DC plan years before we heard about the DB plan closing. We could see the writing on the wall as accounting standards were changing, various competitive forces around the world were converging, and a number of our peer companies were making changes to their retirement benefits.

With that in mind, the investment group started an initially low-profile effort to gather information and gain a deeper understanding of retirement income products that were available. When it came time to actually design and launch an effective solution, we firmly understood the nuances and features of income solutions that were available as well as the various tradeoffs that we needed to consider as a fiduciary who wanted to offer this through a QDIA.

The Lifetime Income Strategy combines the simplicity of a target-date fund with the security of lifetime income, guaranteed by three highly rated insurance carriers in the US.

What is your approach to participant communication and keeping former UTC employees in the plan? There are more than 111,000 participants in our plan — with a wide range of expertise — including some who are quite literally rocket scientists.

Communication has always been a challenge for human beings since the dawn of our species, and it’s no different today in spite of the benefits we get from technology. Consequently, we try to reach employees through a number of different channels.

Electronic communications are definitely a focus, and we have an extensive benefits portal that is available to participants. Through that web-based portal, they can do just about anything they need to.

The plan also includes a very large population of former employees who have made the decision to keep their money in our plan. Personally, I think that’s a good idea for a number of reasons. First, there’s the fiduciary oversight required under ERISA. Not only do we provide the required standard of care, but we’re constantly trying to exceed that standard to make sure that we’re the best we can be. Also, given the scale of the plan, which includes over $21.5 billion of invested assets, we’re able to provide investment options for some of the lowest costs around.

UTC employee savings plan investment lineup: Three approaches at a glance

Choice 1: Let a professional manage it for you Choice 2: Do it yourself (DIY) Choice 3: DIY with more choices Company stock

Age-based Target date based 8 core options Mutual fund brokerage window UTC ownership

Lifetime Income Strategy (QDIA) Custom Target Date Series

• Fixed income• Non-US equity

• Emerging• US equity-small

• Diversifiers• US equity

200520102015202020252030203520402045205020552060

25

50

75

100

%

Stable Value Non-U.S. Developed Equity

Government/Credit Bonds Emerging Markets Equity

U.S. Large Cap Equity Inflation Sensitive Assets

U.S. Small/Mid Cap Equity Multi-Manager Risk Parity

Brokerage window Unitized Company Stock

DC Matters Spring/Summer 2017 9

With regard to keeping former employees in the plan, the company did not necessarily promote that option when the plan launched in 1978, but many people did it anyway. Today, it is a conscious decision on our part to encourage people to keep their money in our plan and keep their options open as to what they might do with that money in the future. And they get the same benefits of scale that our active employees get through a larger plan and lower costs.

By automatically enrolling participants in the Lifetime Income Strategy, participants gain access to a secure stream of lifetime income in retirement.

You mentioned some of the auto features used by the plan. Can you provide more detail on UTC’s automatic enrollment, escalation and employer contribution rates? When Congress passed the Pension Protection Act (PPA) around 10 years ago — and the Department of Labor subsequently published their Safe Harbor for automatic enrollments — we felt more comfortable moving to an automatic enrollment design and did so as soon as we could.

Today, most participants are automatically enrolled at 6%. For those who are eligible for company match, which is a vast majority, they are matched at 60% of that 6% of pay. That gives them a combined contribution of 9.6%.

For employees who were hired after 2009 — and therefore ineligible for the DB plan — many of them also receive an additional automatic, age-based contribution that goes into the DC plan, irrespective of their own payroll contributions. This automatic, company contribution starts at 3% ending up at 5.5% by the time they reach age 50.

So, the overall combined level of contributions — with automatic enrollment, additional matching and automatic age-based contributions — is well in excess of 10% at the outset, and it grows over time as people get closer to retirement age.

Automatic escalation starts at 6% and goes up to 10% as a default, but participants can also increase that if they want. So, most participants who stay with UTC will end up contributing close to 20% of their annual pay on an automatic basis and some may contribute even more.

UTC employee savings plan investment lineup: Three approaches at a glance

Choice 1: Let a professional manage it for you Choice 2: Do it yourself (DIY) Choice 3: DIY with more choices Company stock

Age-based Target date based 8 core options Mutual fund brokerage window UTC ownership

Lifetime Income Strategy (QDIA) Custom Target Date Series

• Fixed income• Non-US equity

• Emerging• US equity-small

• Diversifiers• US equity

200520102015202020252030203520402045205020552060

25

50

75

100

%

Stable Value Non-U.S. Developed Equity

Government/Credit Bonds Emerging Markets Equity

U.S. Large Cap Equity Inflation Sensitive Assets

U.S. Small/Mid Cap Equity Multi-Manager Risk Parity

Brokerage window Unitized Company Stock

10

Plan sponsor forumUnited Technologies Corporation Continued

UTC has adopted a ‘white labeling’ structure. Can you explain your thought process behind the decision and the investment options available? I think generic labeling, or plain language labeling, is really more of a back-to-the-future idea. When the plan launched in 1978, we offered three options with very generic labeling: the equity fund, the income fund and company stock. As the plan developed through the ‘80s and ‘90s, there were additional options added, and some of those were name-brand investments, including mutual funds.

We re-examined the plan about 10 years ago and thought about how we wanted to position it for the 21st Century. We embraced research produced by the behavioral finance community that said most people have a hard time differentiating between a large number of choices. We thought it would be beneficial to our participants if we streamlined the number of choices required to make effective use of the plan.

The very first decision we made was to simplify the plan by introducing automatic enrollment. It shifted the choice from “should I join or not?” to “I’ve been automatically enrolled, do I really want to opt out of my only retirement benefit?”

The second phase we introduced was the investment default. We originally started with a brand-name, off-the-shelf target date series. We evolved to a custom target date solution when we streamlined our investment menu and adopted generic labeling in 2011.

That custom solution evolved into what we’re offering today as our QDIA — the Lifetime Income Strategy. At the same time, we kept the equity fund and the income fund labels that go all the way back to 1978. We also added additional options based on equity indices and a government/credit bond fund.

Even more recently, we added two additional options to the core lineup — a multi-market risk parity fund and an inflation-sensitive assets fund.

Our experience with participants is that the clear labeling and the name of the options have been beneficial.

We thought about how we wanted to position the plan for the 21st Century. We embraced research produced by the behavioral finance community and … streamlined the number of choices.

Can you further discuss the plan’s QDIA default, the Lifetime Income Strategy, and how it’s structured? Lifetime Income is our attempt to combine all the features of a traditional lifecycle saving, investment and income solution into one option that can work as simply as a light switch. All you have to do is turn on the income when you need it in retirement. We call this “Activation.” Everything else is done for you. A professional manager is responsible for the traditional investment allocation in the early years as well as the timing and shape of the glide path as we shift from a pure investment portfolio into a secure income portfolio that holds variable annuity contracts with underlying passive investment funds. All of this is overseen by an ERISA fiduciary.

After a certain point, our participants can exercise their option to turn on their guaranteed retirement income, which is backed by three very well-known and highly rated insurance carriers in the US. Even after formally activating these guarantees, participants always have the freedom and flexibility to change their minds and take their money out. There are no back end or surrender charges. Participants only pay fees on the market value of their assets in the variable annuity contracts while they remain in the contracts. If retirement income is no longer a priority, they can simply pull out some or all of the market value of their investment through an in-plan exchange or an outright withdrawal.

What are some lessons learned you could share with other plan sponsors looking at similar lifetime income options? The fifth anniversary of our lifetime income program will be in June. There

are currently over 27,000 people in the strategy with well over $900 million in assets. It’s our objective to continue refining and developing the Lifetime Income Strategy over time, without making changes that completely disrupt the participants who are already in the option. I like to use an analogy of an automobile. If you think about it, the steering wheel, the accelerator and the brake have all been in the same basic position since the Model T, but everything under the hood has changed. And that’s why we can continue to drive cars without having to re-learn every few years.

I like to use an analogy of an automobile. If you think about it, the steering wheel, the accelerator and the brake have all been in the same basic position since the Model T, but everything under the hood has changed.

An effective retirement income vehicle should work the same way. Now, someone reading this might think, “Well, what about autonomous vehicles?” My response to that is it will be a very long time before I am willing to give up the steering wheel and brakes in my motor vehicle — and that goes for my retirement vehicle, too!

A big part of our ongoing development will be how we communicate the benefits and the ease of use. A lot of that was addressed in the actual design of the option, because it is professionally managed and intended to be easy to use. For the small population who want to go out and make an active choice, it’s as simple as looking at a list of choices in the plan, and selecting the Lifetime Income Strategy. But, it’s hard for some people to believe that it really is all they need to do. So, we are working on clearly communicating that to our participants.

However, the vast majority of participants are defaulting due to the automatic features discussed earlier. The way our program is structured, the guaranteed income will grow as long as participants keep their money in the strategy while they are working. It goes up every time they make a contribution after the age of 48.

DC Matters Spring/Summer 2017 11

Even if a participant stops their contributions at that point and just leaves their money in the option, their guaranteed income will grow between the ages of 48 and 60.

The most important thing a defaulted participant needs to do is activate their income benefit when they retire. A letter is automatically sent to Lifetime Income Strategy participants when they turn 47 that explains they will begin to acquire guaranteed income shortly after turning 48 and the fees they are paying will start to increase as savings shift from the investment-only portfolio to variable annuities. When participants access their benefits statements after they turn 48, they’ll see a new feature that states their income benefit in today’s dollars.

For people who want to understand all of their different options, our online income benefit estimator is a good tool for running different scenarios at any age. It’s designed to look almost identical to the pension calculator that we offer to our DB pension plan participants, which allows you to enter scenarios about your age, when you want to retire, what you think your future contribution will and so on.

With everything UTC has accomplished, are there any stones left unturned? We’re always looking to continually refine and enhance what we’re doing. One thing that we’d like to understand with even more depth and certainty is how to go about valuing the trade-off between flexibility and security. Participants make that ultimate trade-off when it comes to retirement income.

There are research papers and various voices in the investment industry who are promoting different frameworks and quantitative methods that can be applied to that question. We look at a lot of those ideas and constantly try to assess whether or not we can further enhance what we already have in place. As a fiduciary for the participants who are in this plan, we think it’s our responsibility to understand exactly what we offer and what people will need from the plan in retirement.

What would you say is one of your greatest achievements for the participants?I think it’s the stability and security that’s offered by the plan and the ability to meet just about any investment need that we can think of. The plan itself has a wide range of alternatives available through a very streamlined interface.

So regardless of what participants’ personal circumstances might be, they can use all of the options available through the plan very effectively to meet those needs, and probably do so for one of the lowest costs out there.

Regardless of what participants’ personal circumstances might be, they can use all of the options available through the plan very effectively to meet those needs, and probably do so for one of the lowest costs out there.

What advice would you offer other plan sponsors?One of the most important things I’ve learned, based on my experience with the UTC Employee Savings Plan, is that it’s very important to always ask the basic question: What is it you’re trying to achieve and why? Then after asking that question, we take a very hard and honest look at what we’re doing and see if there’s a way to do it better.

Additionally, from a very practical and pragmatic perspective, document everything. Under ERISA, we’re not required to have perfect foresight as fiduciaries. Fiduciaries are required to demonstrate that they have a process for making these assessments, and if someone were to ever question a plan sponsor in the future as to why they did or did not do something in the past, it’s critical to have the evidence readily available to demonstrate what went into that decision. There’s a great quote that comes to mind from the song “Freewill” by the rock band Rush, “If you choose not to decide, you still have made a choice.”

Annuity guarantees are subject to the claims-paying ability of the insurance company. Annuities contain additional risks and charges as well as other factors that should be taken into consideration.

This is not to be construed as an offer to buy or sell any financial instruments. A target date fund identifies a specific time at which investors are expected to begin making withdrawals, e.g., Now, 2020, 2030. The principal value of the fund

is not guaranteed at any time, including at the target date.

There are currently over 27,000 people in the

Lifetime Income Strategy

12

Is the Trump ‘reflation trade’ losing momentum?

Hail to the chief (economist)Global economic outlook

Read John’s blog at blog.invesco.us.com

US 2.2%

Eurozone 1.6%

UK 1.7%

John GreenwoodChief Economist Invesco

Based in London, John Greenwood is Chief Economist of Invesco Ltd. with responsibility for providing economic analysis and forecasts to Invesco portfolio managers and clients.

Summary• The Trump “reflation trade” is being

undermined by the failure of the new administration to implement planned legislation, specifically the Affordable Care Act (the ACA, also known as Obamacare), corporate and personal tax cuts and the border adjustment tax.

• Between Nov. 4 and March 1 US equity markets rallied by 15% to 18%, largely in the expectation that US real gross domestic product (GDP) would accelerate and inflation would also rise, but so far there have been few signs of either.

• Following the 0.25% hike in the US federal funds rate in March, I expect the US Federal Reserve (Fed) will raise interest rates twice more in 2017, taking the target range to 1.25% to 1.50% by year-end 2017.

• In the Euro-area the near-term environment has been and will be dominated by politics — the Italian referendum last December, the Dutch election held in March, the French presidential election in April/May, and the German election in September.

• The economic outlook for the Euro-area remains subdued in the short term, and still far from robust in the long term.

The Trump “reflation rally” has driven global equity markets since the US election, while at the same time generating a meaningful upturn in longer term bond yields. However, with the new president now meeting opposition to his programs — notably his contested executive orders on immigration and his attempt to repeal the ACA — there are starting to be significant doubts about his ability to implement other elements of his program such as the proposed personal and corporate tax cuts, the Ross-Navarro infrastructure spending plan and the repeal of the Dodd-Frank legislation.

DC Matters Spring/Summer 2017 13

Is the Trump ‘reflation trade’ losing momentum?

Invesco’s CPI forecast

CPIUS 2017 CPI inflation forecast

1.9%CPI

Eurozone 2017 CPI inflation forecast

1.4%Source: Invesco as of March 13, 2017

Eurozone 1.6%

Japan 1.2%

2016 inflation and growth

• Consensus real GDP• Consensus CPI inflation

US

%

1.6 1.31.7

0.2

1.80.6

1.0

-0.1

2.5

1.3 1.4 1.4

6.7

2.0

7.0

4.7

IndiaChinaCanadaAustraliaJapanUKEurozone US

-1

0

1

2

3

4

5

6

7

2017 inflation and growth forecasts

• Consensus real GDP • Invesco real GDP• Consensus CPI inflation • Invesco CPI inflation

US

%

2.2 2.3 2.5

1.9

1.6

1.7 1.9 2.

62.

51.

2 0.7 1.

0 2.6

2.7

2.1

1.8 2.

12.

02.

11.

16.

56.

42.

32.

37.

37.

14.

7 5.0

1.6

1.7

1.4

1.1

IndiaChinaCanadaAustraliaJapanUKEurozone US

2

4

6

8

Source: Consensus Economics, survey date, March 13, 2017

2017 consensus real GDP forecast

Following the 0.25% hike in the US federal funds rate in March, I expect the US Federal Reserve (Fed) will raise interest rates twice more in 2017, taking the target range to 1.25% to 1.50% by year-end 2017.

14

• Imported inflation from the depreciation of sterling will reduce UK consumer spending in real terms, while the overall uncertainty about the Brexit terms will undermine foreign direct investment in the country.

• The Japanese economy benefited from mild yen depreciation following the US presidential election, but domestic consumption and investment remain lackluster and are not likely to accelerate during 2017.

• China remains an enigma. On the one hand, rapid credit growth has slowed and interest rates have risen a little, but in a variety of individual markets the authorities continue to apply stimulus measures. At the same time, overcapacity in basic industries such as coal and steel and rising non-performing loans in the banking system are constraining the growth of new investment.

• Despite the upswing in oil and certain metal prices over the past year, the anemic recovery in developed economies and the necessary debt workout in a number of emerging economies imply that the upside for commodities in 2017 is limited.

United StatesIn his first 100 days in office, President Trump is falling far short of his intended progress. His executive orders on immigration have been countermanded by the courts, his reform of the ACA has been stopped and it is looking increasingly unlikely that his plans for personal and corporate tax cuts, the introduction of a border adjustment tax and a profit repatriation scheme will be implemented. His infrastructure spending plans are still in gestation. In contrast, President Trump’s executive orders allowing the go-ahead for the Keystone and XL pipelines and nullifying President Obama’s climate change efforts while blocking the closure of hundreds of coal-fired power stations and restoring the mining of coal are, as of this writing, his only significant achievements. The business of government is proving harder than running a group of unlisted, privately owned companies.

Meantime, despite the strong rally in the stock market, the sell-off in the bond market and the improvement

Hail to the chief (economist)Global economic outlook Continued

Olivia ZZ/Moment/Getty Images

DC Matters Spring/Summer 2017 15

16

Hail to the chief (economist)Global economic outlook Continued

in sentiment indicators, the “hard” indicators such as profits and revenue growth, manufacturing output and real GDP growth have been distinctly lackluster. While it is possible that these may move upwards in coming months, there would need to be an extraordinary jump in performance to achieve a growth rate of “at least 3.5% and as high as 4%.” Among the measures that might be expected to assist in reaching that goal are the president’s intention of rolling back the Dodd-Frank Act on banking regulation and the plan to invest in improving infrastructure. If as a by-product of these changes faster money and credit growth can be achieved, then it is entirely possible that nominal indicators such as final sales, current GDP and corporate profits could start to move upwards more strongly.

It is looking increasingly unlikely that President Trump’s plans for personal and corporate tax cuts, the introduction of a border adjustment tax and a profit repatriation scheme will be implemented.

Abroad, President Trump has said he will renegotiate the North American Free Trade Agreement (NAFTA), has withdrawn from the Trans-Pacific Partnership (TPP) and has threatened to impose substantial tariffs on “currency manipulators” to stop the inflow of subsidized and allegedly illegal products at below-market prices. He has therefore instructed the Commerce Department to prepare an analysis of the underlying sources of the US trade deficit within 90 days.

In the Euro-area the near term environment has been and will be dominated by politics.

The EurozoneIn the Euro-area the near term environment has been and will be dominated by politics. Already, in the referendum of 4 December, the Italian electorate

decisively rejected the proposals of Prime Minister Matteo Renzi for constitutional reform, leaving a political vacuum to be filled by yet another unelected administration, and in the Dutch elections on March 15, the populist party of the right was convincingly defeated. With conventional center-right or center-left governments in France and Germany likely to succeed in the polls during the remainder of 2017, the risk of a disruptive, populist threat to conventional parties appears largely overcome. However, there is still a high level of discontent in Italy (reflected in the popularity of the 5-Star Movement), and in Greece the government is facing debt repayments that will be challenging.

The economic outlook for the Euro-area remains subdued in the short term, and still far from robust in the long term. Among the headwinds holding back a stronger recovery are the slow progress of bank resolution, the fundamentally unsound design of the ECB’s QE program and the subsequent unwarranted descent into negative interest rates.

Unemployment across the Euro-area was 9.5% in February — twice the level in the US or UK — and real household consumption expenditure growth remains at 1.8%.

United KingdomThe UK has continued to defy commentators who predicted a post-Brexit downturn, as the economy’s performance has consistently beaten expectations since June. In November the UK’s fiscal watchdog — the Office of Budgetary Responsibility (OBR) — had to revise up its 2017 GDP estimate from 1.4% to 2%, one of its biggest ever upgrades. So what has confounded the negative forecasts? First, the underlying UK economy has been performing well for several years with GDP growth since 2013 averaging 2.3% annually, aided by the process of private sector balance sheet repair (which has now been largely completed), stable money and credit growth. Thus the UK was the fastest-growing economy in the G7 in 2016. Second, exporters have been the beneficiary of the sterling devaluation with the current account deficit narrowing to 2.4% of GDP in the fourth quarter of 2016, its lowest since 2011. Third, thanks to the UK’s flexible labor market, the economy remains close to full employment.

This strong underlying growth, together with the reality that the imposition of tariffs may not be at all damaging even in a “hard” or “clean” Brexit scenario (and could be offset by a fall in sterling),

Unemployment in Eurozone — wide disparityEurozone unemployment rates %

• Average of Spain & Ireland• Average of France, Italy, Greece & Portugal• Average of Germany, Austria, Finland, & Netherlands

0

5

10

15

20

25

% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Macrobond, data as of April 7, 2017

DC Matters Spring/Summer 2017 17

Follow us on twitter attwitter.com/InvescoUS

has meant that the weakness in investment has not been as great as many expected. There may of course be a long lag, and there may yet be a decline in investment, but signs show that as long as the economy continues to grow and there are tailwinds for exports from the currency depreciation, investment will continue to remain firm.

JapanThanks to an annualized real GDP growth rate of 1.2% in the fourth quarter of 2016, the Japanese economy has now grown for four consecutive quarters — the longest run of growth in three years. This modest growth rate was primarily the result of increased exports, while real private consumption remained subdued at 1.0% year-on-year. The depreciation of the yen has given a boost to exporters and corporate profits, but it is doubtful the increased profits will be passed on to workers in the form of increased wages. The Trump administration plans to crack down on economies that it considers currency manipulators. It has highlighted Japan, China and Germany, which all run large current account surpluses, for having manipulated their currencies.

The Trump administration plans to crack down on economies that it considers currency manipulators, including Japan, China and Germany. Whether the administration takes any countervailing action remains to be seen.

Whether the administration takes any countervailing action remains to be seen. So far, China and Mexico have attracted most of the administration’s opprobrium. One area where Japan may suffer from a US shift to greater protectionism is the possibility of a 20% border tax on imports. This would obviously be a problem for Japanese automakers who export cars, trucks and components from Mexico and Japan into the US, although they also have manufacturing operations in the US.

China and the emerging economiesFiguring out what has been going on in China over the past year has been challenging. On the one hand, government spending accelerated from 8% to 18% between late 2015 and the end of 2016, while the central bank lowered some rates but kept others stable. At the same time, the authorities eased lending standards for mortgages and cut auto sales taxes from 10% to 5%. On the other hand, domestic credit growth in China slowed abruptly from 25% to 17% over the past year, the auto tax was raised again to 7.5% and since November China’s central bank, has started raising interest rates, allowing the Shanghai three-month interbank rate (Shibor) to rise by almost 150 basis points.

Since China is by far the largest EM and the biggest buyer of commodities on world markets, the growth — or lack of growth — of China’s imports matters immensely to many commodity exporters. Unless China can engineer a steady domestic recovery over the next few months, the outlook for those commodity-exporting economies will remain mediocre at best through 2017.

CommoditiesI have been cautious on the outlook for commodity prices over the past three years on the grounds that the recovery in developed economies was still anemic, while emerging economies were either in recession or had big debt problems that would inhibit rapid recoveries. Therefore, the overall demand for commodities would remain weak. However, the recovery of oil and metal prices in 2016 began to suggest that the bear phase might be coming to an end. At the present juncture, with President Trump’s infrastructure plans still on the drawing board and China slowing its credit injections, commodity prices have not taken off, and consequently my forecast remains largely intact. Turning to the oil market, my previous contention that oil prices would stay subdued despite the OPEC production cut has also held true. The key reason was the resilience of the US shale industry, which is ramping up production again.

ConclusionThe Trump “reflation rally” has driven global equity markets since the US election, while at the same time generating a meaningful upturn in longer term bond yields. However, with the new president now meeting opposition to his programs — notably his contested executive orders on immigration and his attempt to repeal the ACA — there are starting to be significant doubts about his ability to implement other elements of his program such as the proposed personal and corporate tax cuts, the Ross-Navarro infrastructure spending plan and the repeal of the Dodd-Frank legislation. While these concerns could well cause stock market momentum to pause, the more important driver of long-term stock market performance is the direction of the US business cycle.

In every business cycle, the value of equities and real estate are fundamentally driven by the level of business activity (or expectations for such activity). In this respect President Trump’s inheritance is a singularly favorable one. Banks and households that were overleveraged in the 2008–09 crisis have mostly completed the repair of their balance sheets, inflation is low and the Fed has been able to start normalizing short-term interest rates. Therefore, there is very little risk to a continuation of the current business cycle upswing in the US. Moreover, because the US is so large and dominant in terms of GDP and its financial impact on credit, equity, real estate and other developed and emerging financial markets, this has hugely important implications for the world economy.

1 Source: Macrobond All data provided by Invesco unless otherwise noted. Where John Greenwood has expressed opinions, they are based on current market conditions as of April 7, 2017 and are subject to change without notice. Unless otherwise specified, data was supplied by Mr. Greenwood.

18

Rafa

el D

ols/

Mom

ent/

Get

ty Im

ages

DC Matters Spring/Summer 2017 19

Is your fixed income under-diversified?

20

Investment cornerCore plus fixed income

Is your fixed income under-diversified?

Fixed Income has never been an area of focus for DC plan sponsors since the emergence of the 401(k). It’s no surprise, with a bond bull market that began in the early ‘80s. Traditional fixed income strategies were very reliable and there wasn’t much for plan sponsors to worry about.

Michael D. Hyman CIO, Global Investment Grade & Emerging MarketsInvesco Fixed Income

Michael Hyman is Chief Investment Officer, Global Investment Grade & Emerging Markets for Invesco Fixed Income. He joined Invesco in 2013 and entered the industry in 1991. Mr. Hyman earned a BSE degree in finance from Pennsylvania State University and an MBA from the Stern School of Business at New York University.

Equity centric investment menusTraditionally, most DC plans have relied on strategies benchmarked to the Barclays US Aggregate Bond Index — “the Agg” — as their primary traditional bond offering. In contrast, most DC plans offer a larger, more diverse set of equity options that evolved from the “style box approach” of the ’90s.

On average, 401(k) plans offer 9.1 standalone equity funds versus just 2.4 bond funds. Equity funds also have the largest share of plan assets (40.6%) versus standalone bonds funds (8%).1 This disparity suggests that fixed income is more of an afterthought to equity-focused DC plans.

Many bond strategies based on “the Agg” index are over weighted in government-related issues and currently have increased interest rate risk.

The growing need for fixed income diversificationWith more participants near or entering retirement, there is a growing need for investments that can serve as a complement to stocks and help provide steady income and growth potential. While traditional high-quality bond portfolios are essential, opportunities for income and return can be missed if bond offerings are limited.

And with an equity-centric core investment menu, does it really make sense to limit core menu bond options to a narrow subset of the fixed income universe?

Did you know?The global bond market is twice as big as the global stock market.2

• Global bond market • Global stock market

Stock market

For illustration purposes only.

DC Matters Spring/Summer 2017 21

With the recent bumps in interest rates — and more expected this year — sponsors should consider options that offer attractive levels of income as well as diversification.

The current low interest rate environment presents an opportunity for plan sponsors to consider more robust fixed income options in the core menu.

The fixed income environment now, and likely for years to come, is very different from the bond bull market that began in the early '80s. Yields are still historically low, but may rise. The underlying risks of an Agg index-based strategy have shifted because it’s current composition is heavily weighted toward government-related bonds, including Treasuries, agencies and agency mortgage-backed securities.

After many years of friendly Federal Reserve policies, these holdings are now subject to significant interest rate risk.

Further rises in interest rates can erode the returns of bond funds based on the Agg. And generating acceptable fixed income returns for DC participants in the coming years may be challenging. Coupled with this investment headwind, there is a not-so-surprising demographic shift where older participants — who need fixed income — also hold a growing percentage of DC plan assets.3

These factors highlight the importance of fixed income options in the DC menu. Furthermore, plan sponsors should consider fixed income strategies with the flexibility to invest a portion of the portfolio outside of the US Agg and have the opportunity to find other sources of return. Employing a core plus strategy is one way to address these issues.

Exposure to higher-quality bonds may complement stocksOne of the benefits of having higher-quality bonds in a fixed income portfolio is the protection they have historically provided during times of stock market turmoil (see Exhibit 3). Historically, when stocks have gone down, high-quality bonds have gone up. This relationship is important for participants trying to achieve greater diversification benefits in their DC accounts. Of course, diversification does not ensure a profit or protect against loss.

The ins and outs of a core plus strategyMost core plus strategies are built upon high-quality portfolios, generally with 80% of assets consisting of investment grade bonds. This may help provide strong principal protection. These strategies usually consist of a diversified portfolio of fixed income instruments benchmarked against the Bloomberg Barclays US Aggregate Index.

Exhibit 1: No single fixed income sector consistently outperforms over time, which makes bond diversification crucial

• 10-year US Treasury• Investment grade corporate

• Mortgage-backed securities• High yield

• Global governments• Emerging market

• BBG BARC aggregate

Annual returns %

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

10.57 20.06 58.21 15.12 17.15 17.92 7.44 10.72 1.51 17.13

9.76 10.23 34.66 12.30 8.15 15.81 -1.41 7.46 1.23 9.69

6.97 8.34 18.68 9.00 7.84 9.82 -1.53 6.08 0.91 6.11

6.90 5.24 5.93 7.90 6.33 4.22 -2.02 5.97 0.55 2.65

4.56 -4.94 5.89 6.54 6.23 4.18 -3.23 5.01 -0.68 1.67

4.16 -14.68 2.63 5.90 6.02 2.59 -4.30 2.45 -3.29 1.65

1.87 -26.16 -9.71 5.37 4.98 1.83 -7.83 -0.79 -4.47 -0.16

Sources: StyleADVISOR, Lipper Inc. as of Dec. 31, 2016. Annual total returns.10-Year US Treasury represented by BofA Merrill Lynch Current 10-Year U.S. Treasury Index, investment grade by BBG BARC U.S. Corporate Index, mortgage-

backed securities by BBG BARC U.S. Mortgage-backed Securities Index, high yield by BBG BARC U.S. Corporate High Yield Index, global governments by BBG BARC Global Treasury Index, emerging markets by the BBG BARC Emerging Market Bond USD Aggregate Index and BBG BARC Aggregate by BBG BARC U.S. Aggregate Index. Past performance is not a guarantee of future results. An investment cannot be made directly in an index.

22

Investment cornerCore plus fixed income Continued

This index is comprised primarily of Treasuries, mortgages, corporate credit and a small amount of structured securities — this is the “core.” The “plus” asset classes typically include high yield, emerging market securities and other foreign bonds.4

When comparing core plus strategies, it is important to analyze each manager’s approach on the “plus” side of the portfolio. Besides the out-of-index exposure, “plus” also means over or underweight various fixed income sectors within the core as an integral part of active fixed income investing. This is often where the differentiators in these strategies reside.

Active management mattersWe believe there is value in active management for this type of strategy. For example, our team currently includes exposure to high yield bonds. These bonds tend to perform well against

Exhibit 2: A core “plus” portfolio includes sectors not typically part of a core bond portfolio and have the potential to provide return and diversification benefits.

%

• Corporate bonds 32.0

• Securitized debt 30.0

• US government bonds 21.0

• Non-US debt 11.0

• Emerging market debt 5.0

• Derivatives 0.5

• Cash 0.5

Charts show percent of total assets of a representative core “plus” portfolio. For illustrative purposes only.

Andrzej Oichawa/Moment/Getty Images

DC Matters Spring/Summer 2017 23

Read our blogs atblog.invesco.us.com

other fixed income assets in a rising rate environment. When rates are rising, high yield bonds may absorb or cushion the losses of that increase in the relatively higher coupon versus other fixed income sectors. That, by definition, means these bonds should outperform Treasuries.

Active management can also address other issues with bond index investing such as limited ability to adjust duration targets and credit exposures in these strategies. We use derivatives exposure such as futures and options to potentially hedge certain risks within the portfolio, such as unwanted interest rate or credit risks.

Active management allows portfolio managers to potentially hedge risk and exploit opportunities in the market.

White label fixed incomeThe advantages of a diversified approach to fixed income can also be accomplished in a white label format. A white label strategy is particularly well suited for fixed income because you can build an option that is simple on the surface, but with some components that would not be feasible as stand-alone options. We believe a core plus strategy may be a good anchor for this type of white label portfolio.

Bottom line Does your plan’s investment menu provide sufficient, diversified fixed income exposure to participants? As more Americans rely on their DC plans as a primary source of retirement savings, it’s important for the investment menu to offer diverse options to help meet their objectives. For plan sponsors reluctant to add another investment option to the lineup, core plus fixed income strategies can offer participants more broad market sector exposure.

1 Source: PSCA 59th Annual Survey of Profit Sharing and 401(k) Plans, all plans, reflecting the 2015 plan experience2 Source: Bonds: BIS total Debt Securities, All Issues, December 2016; Equity: Net Market Cap ($USD) FTSE All-World Index, December 20163 Source: Vanguard, “How America Saves 2011–2016”4 High yield bonds involve a higher risk of default and price movement due to changes in the issuer’s credit quality, while foreign bonds, including those of

emerging markets, may fluctuate more due to increased political concerns, taxation issues, and movements in foreign exchange rates.

Exhibit 3: High-quality bonds have risen when stocks have fallen

• Bonds • Stocks • Periods when stocks were negative

-40

-30

-20

-10

0

10

20

30

40

Returns %

201520122009200620032000

Sources: StyleADVISOR. Data as of Dec. 31, 2016. Bonds are represented by BBG BARC U.S. Aggregate Bond Index and Stocks are represented by S&P 500 Index. Returns shown are average 12-month calendar year-end. Past performance cannot guarantee future results.

24

Participant communicationsThe language of fees

Lisa KuengDirector, Invesco Consulting

Lisa Kueng is a national speaker and the developer of many of Invesco’s consulting programs, including the “Your Prosperity Picture” workshop for women investors and “The New Retirementality,” and is co-author of “Picture Your Prosperity: Smart Money Moves to Turn Your Vision into Reality.” Ms. Kueng has been a keynote presenter at hundreds of industry conferences and has been featured in Business Week, The New York Times, NPR’s “Marketplace Weekend” and Fund Marketing Alert. Ms. Kueng holds a BS degree in journalism with a concentration in speech communications from the University of Illinois and has earned her Registered Corporate Coach designation. She is currently a member of the Invesco Women’s Network, a volunteer for One Million Degrees and a regular guest speaker at Loyola University in Chicago.

Plan fees have become a contentious issue as a result of participant fee disclosure regulations and the barrage of current fee litigation headlines.

The term “fees” has become synonymous with “charges,” and investors have an immediate negative reaction to the term. They view fees as annoying add-ons to the base price, like baggage fees, hotel fees and convenience fees.

For plan sponsors responsible for communicating plan fees to participants, disclosure statements may not be enough. And having the “fee” conversation can be a daunting task.

It’s not just about what you say; it’s about how you say it.Invesco Consulting teamed up with the political consultants and word specialists, Maslansky + Partners to conduct one of the largest, most comprehensive studies of its kind on financial language. The research included measuring investors’ emotional response to words using a unique instant dial response technology. We then conducted a national survey to validate our findings. We found that the word “fees” provoked negative emotional reactions. The word “costs” had a more positive emotional response.

Here’s a very relevant example of how word choice plays an important role when communicating with plan participants.

Which of the following do you LEAST like to pay as an investor?

%

Fees 53

Commissions 26

Charges 15

Costs 6

The numbers won’t speak for themselves

For plan sponsors responsible for communicating plan fees to participants, disclosure statements may not be enough. And, having the “fee” conversation can be a daunting task.

DC Matters Spring/Summer 2017 25

To learn more, visit the participant communication page at invesco.com/dc

As you know, plan sponsors are required to fulfill fee disclosure requirements by providing participants with information they need to know — but aren’t required to read. So why not use language that gets a positive response? People better understand “costs.“ Anything of value costs something, but fees are seen as surcharges that don’t provide any benefit. So when we say ”fees,” that’s what they hear.

What kind of fee arrangement would you prefer?

%

Straightforward 58

Clear 22

Transparent 20

Investors feel like “clear” is accurate but not necessarily complete. “Transparent” is like a prospectus — it contains all the information but is not understandable. That word has also been hijacked by presidents who promised to have a transparent administration then went into closed door sessions. However, “straightforward” implies that an arrangement is honest and understandable. Imagine how this resonates to employees. Just one word could be the difference between making a positive connection with 20% of the participants, or nearly three times as many.

Word choice matters

Just one word could be the difference between making a positive connection with only

20%of the participants, or nearly 60% of participants.

Bottom line Help participants better understand the value, services and costs of their retirement plan so they may better understand the benefits associated with those costs:• Use plain language to promote trust

and encourage employees to use their DC plan more wisely.

• Substitute “plan costs” for “plan fees” and “straightforward” for “transparent” to obtain the best response from participants.

The numbers won’t speak for themselves

”The Language of Fees” is based on the book, The Language of Trust: Selling Ideas in a World of Skeptics, by Michael Maslansky with Scott West, Gary DeMoss, and David Saylor (2010) published by Prentice Hall Press. The Language of Trust: Selling Ideas in a World of Skeptics is based on Invesco Consulting’s ”New Word Order” program, which is derived from our firm’s ongoing research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners.”

This material is for illustrative, informational and educational purposes only. We make no guarantee that participation in this program or utilization of any of its content will result in increased business.

When communicating with participants, lead with the benefits

I just received a statement with all these fees. What am I getting for all these investment management fees?

Response: There’s a lot of information in front of you and we try to be as straightforward as possible to help you with the costs of the plan and investment options. Here are a few things we’re asking you to consider. We are responsible for making sure that all employees have access to a convenient, flexible and competitive retirement plan — a responsibility we take very seriously. Our plan has become much more user-friendly in recent years with better investment options, 24-hour account access and retirement planning tools. These improvements are designed to help make retirement planning easier for everyone, which hopefully results in a more comfortable retirement for employees.

For illustrative purposes only.

26

DC Matters Spring/Summer 2017 27

What’s up on Capitol Hill?Legislative insights

Read Jon’s blog at blog.invesco.us.com

The time may be near for comprehensive US tax reform

Jon VoglerSenior Analyst,Retirement Research,Invesco Consulting

Jon Vogler draws on his extensive pension expertise to offer retirement insights for Invesco. In addition to writing retirement blogs, he tracks legislative and regulatory developments and contributes as a writer and editor to a variety of retirement-related Invesco communications. Mr. Vogler has spent more than 25 years in the research, writing, compliance and underwriting areas of the retirement services industry.

This edition of “What’s Up on Capitol Hill” will explore three areas:1. The effects tax reform might have on

retirement-related issues, including tax incentives for retirement savings.

2. Recent surveys that reveal what the American public thinks about the importance of preserving these incentives, among other considerations, and what key plan features it values.

3. Recent developments in Congress with respect to the controversial proposal to establish state- and municipality-run plans for private-sector workers who do not have access to an employer-sponsored retirement plan.

The House wants to have a revenue-neutral plan, which could potentially affect retirement savings incentives.

Tax reform and its effects on retirement-related issuesHouse Republicans are leading the way on tax reform. They hope to have a proposal unveiled and acted upon prior to the August congressional recess. The House preliminary tax reform plan would reduce corporate tax rates down to 15% or 20%, with an apparent focus on the corporate side rather than on the individual side. The House wants to have a revenue-neutral plan, which could potentially affect retirement savings incentives. Under this scenario, the government would lose revenue from cutting taxes and look instead to other sources to raise revenue, with retirement tax expenditures

While the Trump administration has its hands full with a variety of competing priorities, House Speaker Paul Ryan, R-WI, and House Ways and Means Chairman Kevin Brady, R-TX, recently indicated that tax reform will immediately follow the effort to revise national health care legislation. Restructuring the tax system in a wide-ranging manner hasn’t been done since the Tax Reform Act of 1986.

Jeffrey D. Walters/Moment/Getty Images

Did you know?

83%of workers with access to a retirement savings plan through payroll deduction, are regularly saving.

21%of workers without access to a retirement savings plan through payroll deduction, are regularly saving.

Source: LIMRA, Workers and Retirement Programs: What are they Thinking?, survey as of June 2016

28

What’s up on Capitol Hill?Legislative insights Continued

being a likely target. Lawmakers often see retirement policies as a way to fund other priorities.

Speaking at the Employee Benefit Research Institute’s December 2016 policy forum, Brian Graff, CEO of the American Retirement Association, said retirement savings incentives in the current tax code are an inevitable target to help finance Republicans’ other priorities. “They want to do tax reform that’s revenue-neutral, they want to lower rates, they want to lower taxes on investments and they want to lower corporate rates,” Graff said. “To be revenue -neutral, the money has to come from someplace else, and historically, we [retirement tax preferences] have been a target to pay for other priorities.”1

The idea of how to approach retirement savings within the context of tax reform has been brewing for some time. According to the House task force report on tax reform, released by House Republicans in 2016, “The Committee on Ways and Means will examine existing tax incentives for employer-based retirement and pension plans in developing options for an effective and efficient overall approach to retirement savings.” However, President Trump has not said if he would support or oppose limiting the tax exclusion for retirement plan contributions.

According to some experts, potential tax proposals affecting retirement plans include lowering contribution limits, changing the tax benefits of retirement plans, promoting increased use of Roth contributions and setting lifetime limits on retirement savings. Reductions in retirement savings incentives and lowered contribution limits could have a negative impact on plan formation.

The 2014 tax reform draft from then-Representative Dave Camp, R-MI, would have applied a surtax on retirement savings, frozen contribution limits and subjected 401(k) salary deferrals above one-half of the pre-tax deferral limit (then $17,500) to Roth (after-tax) treatment. One idea floated this time around would be to make all employee contributions to plans or IRAs on a Roth basis going forward, which would represent a significant shift in

retirement policy. The Republicans’ “A Better Way” framework also refers to simplifying retirement choices and perhaps consolidating different types of retirement plans.

It will be several months before we see how the House tax reform plan plays out.

Potential tax proposals affecting retirement plans include lowering contribution limits, changing the tax benefits of retirement plans, promoting increased use of Roth contributions and setting lifetime limits on retirement savings.

Survey supporting tax advantages of DC plansMeanwhile, a study breaking down a new survey released by the Investment Company Institute (ICI) reports that US households “strongly favor preserving retirement account features and flexibility.”2 For example, the vast majority (89%) of all households disagree with the statement that the “government should take away the tax advantages of defined contribution (DC) accounts,” and 90% “disagree with the idea of reducing the amount that individuals can contribute to DC accounts.”

In fall 2016, even 82% of households without DC accounts [such as 401k accounts] or IRAs rejected the idea of taking away the tax treatment of DC

Jeffrey D. Walters/Moment/Getty Images

DC Matters Spring/Summer 2017 29

For more information on bills and resolutions, go to the Library of Congress website at congress.gov

accounts, which is considered critical in promoting plan participation and contributions.

“Our survey demonstrates that DC plan participants appreciate the opportunity to save from every paycheck, as well as the tax treatment for their retirement nest egg that a 401(k) plan offers,” said Sarah Holden, ICI’s senior director for retirement and investor research. “DC plan participants’ overall support for maintaining investment control is strong, and they typically agree that their DC plans offer a good lineup of investment options.”

The ICI research shows that among retirement account-owning households expressing an opinion, 94% “have favorable opinions of 401(k) and similar retirement accounts.”

Workers value key retirement plan features A new study by LIMRA (formerly the Life Insurance and Market Research Association) shows most workers understand the need to save for retirement and prefer to do it through their employers with help from their companies.3

Most workers (75%) prefer to save through their employers. And while workers understand the individual need to save for retirement, 53% said they believe employers should be required to offer retirement plans, and 60% believe employers should contribute to their employees’ retirement plans.

Respondents also said it’s “very important” or “somewhat important” to have a variety of investment options (89%), the ability to take out a loan in case of an emergency (77%), the ability of the employer to contribute to their employees’ accounts (89%) and access to educational meetings and materials about the plans (84%).

“Improving access to worksite retirement savings plans is a critical step in improving retirement security and opportunities for workers,” says Deb Dupont, Associate Managing Director for LIMRA Secure Retirement Institute.

“Workers who have the convenience of being able to save for retirement from a payroll deduction are more likely to save than those who don’t. Previous research showed that among those with access, 83% are regularly saving for retirement, while among those without access, only 21% are regularly saving for retirement.”

83% of workers with access to a retirement savings plan through payroll deduction are regularly saving. Among those without access, only 21% are regularly saving.

State- and municipality-run retirement programs for private-sector employeesOn Aug. 25, 2016, the Department of Labor (DOL) issued final regulations that exempt state-run retirement plans for private-sector employees from the requirements of the Employee Retirement Income Security Act of 1974 (ERISA). While this will allay state fears that the plans would have to be ERISA-compliant, and thus incur additional costs, the retirement industry has reiterated numerous concerns, including:• The result will be a state-by-state

patchwork of different programs with inconsistent rules.

• States should not be exempt from following ERISA and federal securities laws when providing retirement programs for private-sector workers.

• State-run plans could impact private-sector plan offerings in these states.

• Targeted workers are unlikely to participate and contribute at rates that proponents expect.

In addition, some critics are worried that these programs may discourage some employers from offering their own retirement programs.

Proponents of state-run plans — which have gained traction in the absence of a federal IRA program — contend that these plans would provide significant access to retirement savings opportunities for private-sector workers.

To date, eight states — California, Connecticut, Illinois, Maryland, New Jersey, Oregon, Massachusetts and Washington — have passed laws to create state- administered retirement savings programs for private-sector workers whose employers do not sponsor a retirement program. The final measure clears the way for all states to establish such plans, with requirements that the plans must be built and administered by the state, minimize the involvement of employers and have opt-out provisions from automatic enrollment for employees.

Among other requirements to qualify for the “safe harbor” outlined in the final rule, employer participation in these programs would be limited to collecting payroll deductions and passing them on to the program, serving employees with notices about the programs, delivering necessary information about the programs’ operations back to the state and maintaining records.

In addition, on Dec. 19, 2016, the DOL issued final rules governing retirement programs established by large cities and counties as part of the continuing effort to help plug the retirement coverage gap. Like the final rule governing state programs, the rule eases liability risk for municipalities by exempting them from the requirements of ERISA if certain conditions are met.

A handful of major cities, including New York City, Seattle and Philadelphia, have considered launching savings plans under the initial proposal.

However, on Mar. 30, 2017, the Senate passed a resolution which would roll back the ERISA exemption for plans run by large municipalities and subsequently passed a similar resolution affecting state-run plans. The House previously passed similar resolutions blocking the rules which would allow the ERISA exemption for both municipality and state-run plans. Some of the states which have moved forward on these plans contend they will not be deterred by this development. We’ll have to wait and see how this plays out in the coming weeks.

1 Source: Employee Benefit Research Institute, “Retirement policy directions in 2017 and beyond,” Stephen Blakely, Feb. 27, 20172 Source: PlanSponsor, “ICI research highlights broad support for DC plans,” John Manganero, Feb. 24, 20173 Source: Editors@assetinternational.com, “Workers value key features of retirement plans,” Javier Simon, March 2, 2017

30

An academic angleShark attacks?

How distorted mortality beliefs impact savings behavior

Individuals hold distorted views of low-probability events like “shark attacks.” Yet, visions of mortality have important economic consequences.

Dr. Raphael Schoenle’s research spans multiple areas in behavioral economics and finance, including household finance, pricing behavior of firms, macro- and monetary economics, and international macroeconomics. This interview features his latest research — conducted jointly with Dr. Rawley Heimer, Federal Reserve Bank of Cleveland and Professor Kristian Myrseth, Trinity College Dublin — on the connection between distorted mortality beliefs and savings behavior — based on the research paper, “YOLO: Mortality Beliefs and Household Finance Puzzles.”

Dr. Raphael Schoenle, Ph.D.Associate Professor of EconomicsBrandeis University

Dr. Raphael Schoenle is an assistant professor of economics at Brandeis University. His research spans behavioral economics and finance, household finance, pricing behavior of firms, macro- and monetary economics, and international macroeconomics. His work on inflation dynamics during the financial crisis was presented at the 2015 Economic Policy Symposium in Jackson Hole. Dr. Schoenle is a recipient of the 2012 Young Economist Award from the Austrian Economic Association. He is a research associate at the Federal Reserve Bank of Cleveland and a visiting researcher at the Bureau of Labor Statistics. Dr. Schoenle graduated magna cum laude from Harvard University with an A.M. in statistics and A.B. in economics. He also earned an M.A. and Ph.D. in economics from Princeton University.

DC Matters Spring/Summer 2017 31

What prompted you to pursue research on mortality beliefs? What kinds of questions were you seeking to address?We all have, at some point or another, thought about death and how long we are going to live. Remember the last time you stepped on a plane? Did you think about the possibility of a plane crash? As an economist, I became interested in survival beliefs prompted by two big puzzles about savings and consumption:

1. The young consume too much, and save too little for retirement. Moreover, there is research that shows that about one third to one half of the population are so-called “hand-to-mouth” consumers and have essentially no savings whatsoever (Campbell and Mankiw, 1989, Kaplan et al. 2014).

2. During retirement, we consume too little and save too much. Research shows that wealth keeps increasing during retirement. For example, in a group of 70- to 75-year-olds, wealth increases by about 4% per year (Love et al., 2009).

Because consumption is so crucial for our well-being, understanding these savings and consumption decisions is a first-order, social question in economics.

Another deep, motivating question for us in this project was, what makes people save? We know that the decision of how much to save is tied to many factors such as risk aversion, liquidity constraints, income, the extent to which we have precautionary motives, bequest motives, and many other factors. But quite crucially, these decisions are also connected to the beliefs we have that we’ll be around tomorrow.

If we think we will not be around tomorrow, then rationally, we should have a big party today. If we think we will be around tomorrow, then we should save some of our cash today — so we can consume tomorrow.

From an academic perspective, studying survival beliefs is appealing because we know what our beliefs should be — at least, on average based on Social Security probability statistics. This possibility of having a very clearly defined benchmark and knowing the true implied expectation errors is what got me especially excited about this topic of survival beliefs.

Our research included an examination of these survival beliefs and how they can relate to the potentially important economic consequences of the two big financial puzzles — low savings by the young, high savings by the old — and what could be a driving factor behind such systematic mistakes.

Dave Fleetham/MediaBakery.com

32

An academic angleShark attacks? Continued

Can you describe the approach to your research?We surveyed 5,000 respondents, screened according to national residency and age. We required all respondents to be US residents with English as their primary language. Respondents were drawn from the following six ages: 28, 38, 48, 58, 68 and 78, with the distribution roughly matching the relative proportion of the population at each age.

… younger respondents substantially underestimate their survival probabilities, while older respondents substantially overestimate their chances of survival.

The survey specifically targeted these ages to avoid respondents who are about to or have recently reached milestone ages, such as age 40. We also surveyed an equal gender distribution.

We asked respondents to indicate their survival likelihood beliefs — that they would live at least an additional one, two, five and 10 years. We found that the younger respondents substantially underestimate their survival probabilities, while older respondents substantially overestimate their chances of survival.

Next, we gauged cognitive factors that respondents use to construct their beliefs, as well as their personal assessment of the frequency of rare deaths. We asked respondents to indicate the weight they place on certain causes of death when assessing their own chances of survival.

The causes of death can be categorized as natural causes, such as aging and health, or disastrous events, such as car and plane crashes. We found misperceptions here as well.

What drives our misconceptions around the idea of our own mortality? Consider this: Most of us are fascinated by sharks, and our perceptions of the probability of dying from a shark attack are probably exaggerated. But in fact, we should be more afraid of cows. Figure 1 shows the average annual animal-caused fatalities in the US. On average, one person dies from a shark attack each year, but 20 people die at the hooves of killer cows.

Figure 1: Scared to swim in the ocean? The ‘deadliest’ animals may not be the ones you expect Average annual animal-caused fatalities in the US, 2001 to 2013

Other mammals kill 52 people

Bees, wasps and hornets kill 58 people

Spiders kill 7 people Venomous reptiles kill 6 people

Non venomous arthropods kill 9 people

Cows kill 20 people

Dogs kill 28 people

Bears kill 1 person Sharks kill 1 person

Source: CDC reports, CDC Wonder database, Wikipedia, Florida Museum of Natural History

DC Matters Spring/Summer 2017 33

What this example really illustrates is that salience of causes of death can distort our mortality beliefs. As mentioned, we wanted to uncover where the bias in survival beliefs is coming from. Overweighting rare, but salient, mortality risks can help explain this bias.

As I mentioned above, we also asked respondents, “When you assessed your survival likelihood, to what extent did you place weight on the following risk factors?” We gave people a choice of natural risk factors — the natural course of life and aging, medical conditions, dietary habits — and a choice of rare-disaster risk factors, such as animal attacks or homicide. People correctly placed more weight on the natural risk factors.

Financial decisions are connected to the beliefs we have about our own mortality.

However, as we see in Figure 2, people vastly overweight rare-disaster risk factors, such as shark attacks. Those perceptions are completely out of proportion with reality. And one of our connected key results is that younger people —with pessimistic survival beliefs — are the ones who put the most weight on the rare-disaster risk factors, while older people — who tend to be survival optimists — place more weight on the natural risk factors.

We found an interesting reality check in these survey responses. When we looked at gender differences, men put significantly more weight on a risky lifestyle and traffic accidents than they did on medical conditions or dietary habits — which is consistent with evidence that men are riskier drivers who pay higher insurance premiums and who tend to ignore medical advice.

Younger people — with pessimistic survival beliefs — put more weight on the rare-disaster risk factors, while older people — who tend to be survival optimists — place more weight on the natural risk factors.

Figure 2: Views of mortality risk change with age Younger people are more concerned about rare disasters than older people

• Age 28 • Age 38 • Age 48 • Age 58 • Age 68 • Age 78

Freak events

Risky lifestyle

Animal attacks

Natural disasters

Physical violence

Traffic accidents

Dietary habits

Medical conditions

Natural course of aging

5

10

15

20

25

30

%

Rare event risksHealth risks

Data based on the following survey question: When you assessed your survival likelihood, to what extent did you place weight on the following risk factors?

34

An academic angleShark attacks Continued

How can your research relate to financial decision-making?In a nutshell, one’s subjective perceptions about causes of death can be a driver of distorted survival beliefs. And these distortions are meaningfully related to financial decision-making.

In particular, individuals who are pessimistic about their survival live “hand-to-mouth,” meaning they consume their entire current income, or even rely on credit card debt. At the same time, optimists are the ones who save. Optimists are not the only ones who save, but they are also much more likely to run down their savings much later in life.

For example, when people’s survival pessimism increases from really small to really large in the data, they become 15% more likely to live “hand-to-mouth.” This is an economically significant relationship, and it doesn’t go away if we control for factors such as education, income or financial literacy.

In addition, subjects in their 30s tend to overconsume — or undersave — by about $2,000 per year, according to

our research. Then, when they retire, they have about 30% lower savings than under the correct beliefs.

At what point do one’s mortality beliefs and savings/consumption behaviors change?Our research found that beliefs tend to change pretty much around retirement. This is true for both survival beliefs and longevity beliefs — the age we expect to die.

Retirees are apt to overestimate long-term survival rates, which implies 15% less retirement consumption than optimal.

As you can see in Figure 3, the purple line shows the subjective probability (personal beliefs) and the blue line shows the objective probability (Social Security statistical data). What this tells us is that the young are relatively pessimistic about reaching age 95, while the retired are relatively optimistic about reaching age 95. The switch in belief from pessimism to optimism “flips” around age 65.

For example, a 28-year-old female thinks she will reach age 95 with 2% probability, but the true probability is about 11%. As you can see, the bias flips during retirement for both men and women.

How can this model be useful? Basically, our model — plus subjective beliefs — predicts early-life overconsumption and retirement underconsumption.

Personal beliefs of reaching age 95 changes as people get older

• Perceived • Actual

280.7%

4.9%

Predicts early life overconsumption

78

8.9%

15%

Predicts retirement underconsumption

Figure 3: The young are pessimistic about reaching age 95, while retirees are optimistic Personal beliefs (subjective) vs. actuarial data (objective)

• Subjective probability • Objective probability

0

20

40

60

80

100

9528 78 8838 48 58 68%

Female respondent age

Crosses over at retirement

0

20

40

60

80

100

9528 78 8838 48 58 68%

Male respondent age

Crosses over at retirement

DC Matters Spring/Summer 2017 35

Visit http://people.brandeis.edu/~schoenle/ to read more of Dr. Schoenle’s research

Unless otherwise noted, research based on Rawley Heimer, Kristian Ove R. Myrseth and Raphael Schoenle, “YOLO: Mortality Beliefs and Household Finance Puzzles,” FRB of Cleveland Working Paper No. 15–21, Jan. 19, 2017.

Key takeaways

Takeaway 1 Takeaway 4

There’s a strong correlation between mortality beliefs and savings — even after controlling for financial and numerical literacy, income, demographic and educational differences.

Consumers decide whether to save or consume throughout the life-cycle. Thus, even small financial mistakes incurred by modest short-run mortality belief distortions can accumulate into large financial shortfalls by retirement and beyond.

Takeaway 2 Takeaway 5

On average, younger individuals have more pessimistic survival beliefs, which are associated with a greater propensity to not save or even to rely excessively on credit cards on a month-to-month basis.

Raising probability literacy can help drive awareness of our beliefs — and look more closely at reality — to help individuals evaluate how reasonable they are.

Takeaway 3 Takeaway 6

As individuals grow older, they go from underestimating to overestimating their expected longevity.

Biased mortality beliefs can add additional credence to the benefits of automatic enrollment and automatic escalation features.

More to come My research team and I are currently running experiments with The National Employment and Savings Trust (NEST) in the UK to see whether we can nudge people into correct beliefs when they sign up for retirement contributions.

Based on your research, what is most likely to have an impact on how we help people save for retirement? Because there are such dramatic distortions in our survival beliefs, I believe there is a big need to study and think more about what I call “probability literacy.”By that, I mean that we need to understand people’s ability to reflect on their own beliefs, how they arrive at those beliefs, and probabilities to help them make more informed financial decisions. I believe this has equal importance to financial literacy, which studies people’s ability to understand the role of bonds versus stocks, or the concept of diversification.

The magnitude of the relationship between survival beliefs and savings behavior is at least as large as that between savings behavior and financial literacy.

DC Matters Spring/Summer 2017 36

DC Matters Spring/Summer 2017 37

Which methodology is best for your plan?

Nuts & boltsAllocating fees

In the current market environment, the extensive scrutiny of fees and the need for fee transparency have resulted in organizations seeking the most equitable way to allocate defined contribution (DC) plan expenses. While the Department of Labor (DOL) requires plan fiduciaries to closely monitor fees and ensure they are competitive and reasonable, it has not specified a method by which fees must be allocated among participants.

Earle W. Allen, MBA, CEBS PartnerCammack Retirement Group

Earle Allen joined Cammack Retirement Group in 1990 and has over 25 years of experience providing consulting and advisory services to defined contribution plan sponsors. Mr. Allen manages the relationships with several of Cammack’s public and private academic institutions, as well as other nonprofit organization employers, helping them fulfill their fiduciary responsibility to their plan and achieve best practices in plan administration. Mr. Allen received his bachelor’s degree from Dartmouth College and an MBA from New York University’s Stern School of Business.

Paying for the administration of a retirement plan adds an expense to the bottom line … most plan sponsors have chosen to pass these expenses on to their participants.

The simplest way to pay for recordkeeping expenses is for the plan sponsor to pay all fees directly, eliminating any question about the fairness of fee allocation among participants. However, most organizations are under pressure to reduce expenses and do not want to assume these plan fees. Paying for the administration of the retirement plan adds an expense to the bottom line, which most plan sponsors have chosen to pass on to their participants.

There are numerous options available to allocate plan expenses among participants, each having its own positive and negative attributes. This article explores the three most popular models and the associated benefits and drawbacks.

Three popular modelsThere are three commonly used participant fee allocation approaches. The first two models use “revenue sharing,” also known as recordkeeping offset, as a key component to pay for recordkeeping fees. Revenue sharing amounts are fees built into the expense ratios of the plan investments, used to offset plan expenses. Typically, recordkeeping fees are the primary expense covered by revenue sharing.

Monty Rakusen/MediaBakery.com

38

Nuts & boltsAllocating fees Continued

1. Expense reimbursement account (ERA) model 2. Fee levelization model 3. Flat fee model

How it works – Often referred to as a revenue credit account, the recordkeeper charges a flat rate of “required revenue” for its services. This is typically expressed as a percentage of plan assets (e.g., 0.20%). Revenue sharing amounts in the plan investments are then applied to these fees.

– If the total revenue sharing is insufficient to meet the cost, the recordkeeper charges an additional fee to cover the shortfall. Plan sponsors may elect to pay this amount directly or to pass it on to participants.

– If the total revenue sharing exceeds the required revenue, the excess amount is allocated to the plan’s ERA.

– Sponsors can use this excess revenue sharing to pay for legitimate plan fees, such as auditors, legal counsel, advisors, communication initiatives and other plan expenses, or return the excess amount back to participants.

– Under this increasingly popular model, the recordkeeper applies the required revenue to each individual investment option. If the investment has exactly the required revenue amount (such as 0.20%) in revenue sharing built into its expense ratio, then the fees match.

– If the fund exceeds the required revenue (e.g., 0.25%), the recordkeeper credits each participant who has assets in the fund with the excess amount (e.g., 0.25% minus 0.20% would equal 0.05% credit returned to the participants).

– If the investment provides less than the required revenue amount, the recordkeeper adds a “wrap” fee in the amount of the shortfall to the accounts of each participant using the investment.

– Participants with several different investments might experience multiple credits and debits based on the revenue sharing in each investment, relative to the required revenue.

– The same amount is charged to each participant. – The recordkeeper charges a fee and deducts the stated

amount from each account either annually or quarterly. The participants see this amount on their statements.

Benefits and drawbacks – One challenge with this model is the variability of the revenue sharing built into the investments. Not every investment contributes the same revenue sharing amount toward meeting plan expenses.

– When replacing an investment in the lineup, sponsors should be mindful of revenue sharing amounts available in the new investment — relative to the one being replaced — so revenue sharing will be sufficient to cover recordkeeping costs.

– Participants do not share the cost of the recordkeeping fees equally. Depending on the individual investment allocation, participants may be paying a proportionate share of the plan fees, or an amount that is more or less than the required revenue. For example, if the required revenue is 0.20%, and some participants select investments that pay 0.25% in revenue sharing, those participants are contributing 0.05% more than their proportionate share of the fees.

– Under this model, some participants end up paying the recordkeeping fees for others.

– This model solves both the overall plan collection problem and the individual participant allocation concern.

– Regardless of how participants allocate their assets, the revenue sharing received by the recordkeeper will be exactly enough to pay for its fees.

– All participants contribute an equal, proportionate share of the plan recordkeeping fees, regardless of their selected investments. While the dollar amount is not the same, participants do pay the same percentage share of the total plan assets.

– Participants with larger account balances contribute greater dollar amounts than those with smaller balances. For example, a participant with a $100,000 account balance pays $200 per year, whereas a participant with a $10,000 account balance pays only $20 per year. While it is possible that the participant paying $200 may utilize more of the recordkeeper’s services than the participant paying $20, it is unlikely to be ten times the amount of services.

– There may be confusion for participants as they encounter the associated fee credits and/or wrap fees on their quarterly statements. Plan sponsors need to distribute communication materials to help explain the statement listings and respond to inquiries that arise.

– Plan sponsors can simplify fee levelization by selecting investment options with no built-in revenue sharing. With zero revenue sharing, the recordkeeper needs to charge the full required revenue amount to each investment. This is typically easier for participants to grasp, rather than a series of credits and debits.

– Constructing a lineup of entirely zero revenue-sharing funds may not be possible, and it also depends on the investments available on the recordkeeping platform.

– This is the simplest methodology to implement and communicate to participants.

– Since each participant has the same access to the recordkeeper services, it is easy to philosophically justify having everyone pay the exact same amount.

– Participants with lower account balances pay a significantly greater portion of their balance when paying the flat fee. In a plan with a $100 annual recordkeeping fee, a participant with a $10,000 balance pays 1% of his or her assets for fees, whereas a participant with a $100,000 account balance pays 0.10%.

– To combat this issue, some sponsors may establish a minimum participant account balance (e.g., $20,000) before implementing the annual fee.

DC Matters Spring/Summer 2017 39

For more information, visitcammackretirement.com.

1. Expense reimbursement account (ERA) model 2. Fee levelization model 3. Flat fee model

How it works – Often referred to as a revenue credit account, the recordkeeper charges a flat rate of “required revenue” for its services. This is typically expressed as a percentage of plan assets (e.g., 0.20%). Revenue sharing amounts in the plan investments are then applied to these fees.

– If the total revenue sharing is insufficient to meet the cost, the recordkeeper charges an additional fee to cover the shortfall. Plan sponsors may elect to pay this amount directly or to pass it on to participants.

– If the total revenue sharing exceeds the required revenue, the excess amount is allocated to the plan’s ERA.

– Sponsors can use this excess revenue sharing to pay for legitimate plan fees, such as auditors, legal counsel, advisors, communication initiatives and other plan expenses, or return the excess amount back to participants.

– Under this increasingly popular model, the recordkeeper applies the required revenue to each individual investment option. If the investment has exactly the required revenue amount (such as 0.20%) in revenue sharing built into its expense ratio, then the fees match.

– If the fund exceeds the required revenue (e.g., 0.25%), the recordkeeper credits each participant who has assets in the fund with the excess amount (e.g., 0.25% minus 0.20% would equal 0.05% credit returned to the participants).

– If the investment provides less than the required revenue amount, the recordkeeper adds a “wrap” fee in the amount of the shortfall to the accounts of each participant using the investment.

– Participants with several different investments might experience multiple credits and debits based on the revenue sharing in each investment, relative to the required revenue.

– The same amount is charged to each participant. – The recordkeeper charges a fee and deducts the stated

amount from each account either annually or quarterly. The participants see this amount on their statements.

Benefits and drawbacks – One challenge with this model is the variability of the revenue sharing built into the investments. Not every investment contributes the same revenue sharing amount toward meeting plan expenses.

– When replacing an investment in the lineup, sponsors should be mindful of revenue sharing amounts available in the new investment — relative to the one being replaced — so revenue sharing will be sufficient to cover recordkeeping costs.

– Participants do not share the cost of the recordkeeping fees equally. Depending on the individual investment allocation, participants may be paying a proportionate share of the plan fees, or an amount that is more or less than the required revenue. For example, if the required revenue is 0.20%, and some participants select investments that pay 0.25% in revenue sharing, those participants are contributing 0.05% more than their proportionate share of the fees.

– Under this model, some participants end up paying the recordkeeping fees for others.

– This model solves both the overall plan collection problem and the individual participant allocation concern.

– Regardless of how participants allocate their assets, the revenue sharing received by the recordkeeper will be exactly enough to pay for its fees.

– All participants contribute an equal, proportionate share of the plan recordkeeping fees, regardless of their selected investments. While the dollar amount is not the same, participants do pay the same percentage share of the total plan assets.

– Participants with larger account balances contribute greater dollar amounts than those with smaller balances. For example, a participant with a $100,000 account balance pays $200 per year, whereas a participant with a $10,000 account balance pays only $20 per year. While it is possible that the participant paying $200 may utilize more of the recordkeeper’s services than the participant paying $20, it is unlikely to be ten times the amount of services.

– There may be confusion for participants as they encounter the associated fee credits and/or wrap fees on their quarterly statements. Plan sponsors need to distribute communication materials to help explain the statement listings and respond to inquiries that arise.

– Plan sponsors can simplify fee levelization by selecting investment options with no built-in revenue sharing. With zero revenue sharing, the recordkeeper needs to charge the full required revenue amount to each investment. This is typically easier for participants to grasp, rather than a series of credits and debits.

– Constructing a lineup of entirely zero revenue-sharing funds may not be possible, and it also depends on the investments available on the recordkeeping platform.

– This is the simplest methodology to implement and communicate to participants.

– Since each participant has the same access to the recordkeeper services, it is easy to philosophically justify having everyone pay the exact same amount.

– Participants with lower account balances pay a significantly greater portion of their balance when paying the flat fee. In a plan with a $100 annual recordkeeping fee, a participant with a $10,000 balance pays 1% of his or her assets for fees, whereas a participant with a $100,000 account balance pays 0.10%.

– To combat this issue, some sponsors may establish a minimum participant account balance (e.g., $20,000) before implementing the annual fee.

40

Nuts & boltsFiduciary outsourcing Continued

For more information, visit invesco.com/dc

Important information This material is provided for general information only. Information does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

All of these fee arrangements are viable options, as long as the total amount of fees paid are aligned with the value of the services provided, and the allocation of fees among participants is reasonable.

Plan sponsor decisionsIn most cases, philosophical perspectives will drive an organization’s decisions when it comes to allocating DC plan expenses. There is no one correct answer in making the judgment as to which fee allocation model to select. With the lack of guidance from the DOL, the circumstances and individual perspective of an organization will often make one model a more logical

choice than the others. All of these fee arrangements are viable options, as long as the total amount of fees paid are aligned with the value of the services provided, and the allocation of fees among participants is reasonable.

Jochen Tack/MediaBakery.com

DC Matters Spring/Summer 2017 41

About us

At Invesco, we’re dedicated to delivering an investment experience that helps people get more out of life.

We offer a wide range of investment capabilities across equity, fixed income and alternative asset classes, delivered through a diverse set of investment vehicles.

By the numbers

Providing investment solutions to DC plan sponsors

36 yearsGlobal assets under management

$834.8 billionDC assets under management

$101.5 billionAlternative investment strategies under management

$127.2 billionFixed income and money market investment strategies under management

$276.9 billionEquity investment strategies under management

$381.8 billionBalanced investment strategies under management

$48.9 billionEmployees worldwide

>6,500Cities worldwide where Invesco has on-the-ground presence

29Countries where Invesco serves clients

120

Invesco

Source: Invesco Ltd. Client-related data, investment professional, employee data and AUM are as of March 31, 2017, and include all assets under advisement, distributed and overseen by Invesco. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products. The entities listed are each indirect, wholly owned subsidiaries of Invesco Ltd., except Invesco Great Wall in Shenzhen, which is a joint venture between Invesco and Great Wall Securities, and the Huaneng Invesco WLR Investment Consulting Company Ltd. in Beijing, which is a joint venture between Huaneng Capital Services and Invesco WLR Limited. Please consult your Invesco representative for more information.

Not all products are available to all investors. Please consult your Invesco representative for more information.Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.

Institutional Separate Accounts and Separately Managed Accounts are offered by Invesco Advisers, Inc. and other affiliated investment advisers, which provide investment advisory services and do not sell securities. Invesco Distributors, Inc. is the U.S. distributor for Invesco Ltd.’s retail mutual funds, exchange-traded funds and institutional money market funds. Both are indirect, wholly owned subsidiaries of Invesco Ltd.

Follow us on twitter attwitter.com/InvescoUS

For more information, visit invesco.com/dc

Read our blogs at blog.invesco.us.com

Explore High-Conviction Investing with Invesco

FOR DEFINED CONTRIBUTION PLAN SPONSOR USE ONLY — NOT FOR USE WITH THE PUBLIC

The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. The comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations. Past performance is no guarantee of future results.

This magazine is not intended to be legal or tax advice or to offer a comprehensive resource for tax-qualified retirement plans. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. The information presented is based on current interpretation of pending retirement legislation and regulations. State laws may differ. Always consult your own legal or tax professional for information concerning your individual situation. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed.

This magazine is for informational purposes only and is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing.

Note: For more information on any of the topics discussed please contact your Invesco Representative.

10-Year U.S. Treasury Index is a debt obligation issued by the United States government that matures in 10 years. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity. An advantage of investing in 10-year Treasury notes, and other federal government securities, is that the interest payments are exempt from state and local income tax. However, they are still taxable at the federal level.

BBG BARC U.S. Investment Grade Corporate Index is an unmanaged index consisting of publicly issued US Corporate and specified foreign debentures and secured notes that are rated investment grade (Baa3/BBB- or higher) by at least two ratings agencies, have at least one year to final maturity and have at least $250 million par amount outstanding.

BBG BARC U.S. Mortgage Backed Securities Index represents mortgage-backed pass-through securities of Ginnie Mae, Fannie Mae and Freddie Mac. BBG BARC U.S. Corporate High Yield Index is an unmanaged index considered representative of fixed-rate, noninvestment-grade debt. BBG BARC Global Treasury Index tracks fixed-rate, local currency government debt of investment grade countries, including both developed and emerging markets. BBG BARC Emerging Markets Hard Currency Aggregate Index is composed of USD-, euro- and GBP-denominated debt from sovereign, quasi-sovereign, and

corporate emerging markets issuers and is considered representative of hard currency emerging markets debt. BBG BARC U.S. Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market. An investment

cannot be made directly in an index.Invesco Distributors, Inc. is not affiliated with United Technologies Corporation, Cammack Retirement Group or Brandeis University.

invesco.com/dc DCMTRS-BRO-5 05/17 Invesco Advisers, Inc. Invesco Distributors, Inc. US5466

About riskBond issuers may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate

more than those of high quality bonds and can decline significantly over short time periods.The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political

and economic instability, and foreign taxation issues.Mortgage- and asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower’s payments may be received

earlier or later than expected due to changes in prepayment rates on underlying loans. Securities may be prepaid at a price less than the original purchase value.

Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.

Investing in stock involves risks, including the loss of principal and changes in dividend policies of companies and the capital resources available for dividend payments. Although bonds generally present less short-term risk and volatility than stocks, investing in bonds involves interest rate risk; as interest rates rise, bond prices usually fall, and vice versa. Bonds also entail credit risk and the risk of default, as well as greater inflation risk than stocks. Treasury bills are guaranteed by the full faith and credit of the US government as to the timely payment of principal and interest; however, this guarantee does not eliminate market risk. Corporate bonds may offer a higher yield than government bonds but are often considered riskier because they're not issued by the government. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

Diversification does not guarantee profit or eliminate the risk of loss