retirement age could not both work for and receive pension benefits from the same employer.

The Pension Protection Act of 2006 changed federal tax law so that a worker who has reached age 62 can receive in service pension distributions, if the employer is willing to modify the provisions of the DB pension so as to permit such distributions. Although phased retirements are rare today, the economy is moving in directions that are likely to make phased retirement more prevalent. Trends in pensions, flexible hours, and legislation may encourage phased retirement. As healthier baby boomers move toward retirement, they are more likely to

express an interest in continued work. Moreover, they may need to work in part because of changes in Social Security and in part because their pensions and savings have not kept pace with their desired level of consumption. In recent decades, the fraction of the workforce covered by a DB pension has dropped, while the fraction covered by DC pensions has grown. Since DC plans are more conducive to phased retirement than DB plans, this trend is likely to bring greater opportunities for phased retirement. The 10-page article is available online. Web site: www. bc.edu/centers/crr/issues/wob_8.pdf I

401(k) TRADING

Do Traders Win? Trading Behavior and 401(k) Portfolio Performance

Gary R. Mottola and Stephen P. Utkus, Vanguard Center for Retirement Research, January 2007

ne critical aspect of investment decision-makingtrading activityhas received only limited attention. From our prior research, we know that defined contribution (DC) plan participants trade infrequently. We estimated that only 20% of participants traded during the 2003 to 2004 period, and most in that group executed only one trade. The few who traded regularly tended to be affluent, older men with long job tenure. They typically held more funds in their portfolios and were less likely to invest in index or life-cycle funds. Overall, 401(k) traders and nontraders appear to earn the same risk-adjusted returns. Among traders, lowturnover strategies such as rebalancing are beneficial, while high-turnover trading is costly. Participants who hold only balanced or life-cycle funds, who we refer to as passive rebalancers, earn the highest risk-adjusted returns. Passive rebalancers, who hold only balanced or life-cycle funds so are automatically rebalanced by their fund, realized excess annual returns of 84 basis points compared with nontraders on a risk-adjusted basis. Active rebalancers, who on their own move their 401(k) portfolios equity allocation back to a given

target, earned 26 basis points in excess risk-adjusted returns. However, we estimate that only 9% of participants rebalanced their 401(k) account on an active or passive basis. While some level of trading is a return-enhancing strategy, high portfolio turnover is not. Traders with the highest turnover rates lost 72 basis points per year compared with traders with the lowest turnover ratios. Our findings underscore the value of rebalancing as an essential strategy for 401(k) participants. All other things being equal, plan features such as life-cycle or balanced funds, managed accounts, or automatic rebalancing services, will lead to higher risk-adjusted returns. In addition, there may be a longer-term case to be made for making rebalancing the default for all participant accounts. Finally, since high turnover harms investment performance, discouraging active tradingthrough education, plan policies, or fees should produce superior risk-adjusted returns. This 12-page paper is available online. Web site: www. investmentnews.com/assets/docs/CI14790329.pdf I

TRENDS

2006 Retirement Plan Trends: The Total View

The Principal Financial Group, March 20, 2007

Defined Contribution Plans nvestment returns and participant contributions have led to yet another year of double-digit

increases for average account balances in defined contribution (DC) plans (Figure 6, page 11). The average account balance has increased by 13% from
July 2007

10

Figure 6. 401(k) Overall Plan Participant Average and Median Account Balances, 20022005
Average Account Balance 2002 2003 2004 2005 $27,282 $34,344 $40,125 $45,186

Median Account Balance 2002 2003 2004 2005 $20,165 $25,355 $30,005 $33,269

Source: The Principal Financial Group, March 20, 2007

2004 and by more than $15,000 since 2002. This increase in average account balances is seen across the industry. Average account balance increases since 2004 for: All participants (including employees for whom gender data are not coded): 13% Women: 11% Men: 12% Highly compensated employees: 16% Non-highly compensated employees: 11% The average account balance for employees with 16 or more years of service: just under $100,000; for less than one year of service, it is $4,000. The average pre-tax deferral rate is 7.1%. Average default deferral rate for plans using automatic enrollment is 3.3%. The most common default deferral rate for plans using automatic enrollment is 3%. The overall participation rate is 68%. Businesses in the financial, insurance, and real estate industry have the highest participation rates, both within [our] client base and the marketplace as a whole. Younger individuals participate at much lower rates than older employees do. Those aged 5064 years old participate at the highest rates (73%). Individuals with a salary greater than $30,000 participate at significantly higher rates than those making less than $30,000.
July 2007

Participation rates are 6% higher in plans that offer automatic enrollment. Industry-wide, more than 12% of 401(k) plans offer automatic enrollment, and more and more employees are open to the idea of automatic enrollment. Passage of the Pension Protection Act (PPA 06) will undoubtedly increase automatic enrollment acceptance [this year]. Defined Benefit Plans Although most sponsors of DB plans realize that PPA 06 may result in the need for larger contributions, 63% expect the actual impact to be manageable. Seventeen percent of respondents say they are likely to eliminate their plans for future hires, and 5% will likely freeze benefits for current employees; however, 49% intend to continue their current pension plans with the same or similar benefits as are offered today. Forty-five plans [using our] plan services froze or terminated in 2005; most plans were from smaller employers, and the average size of a DB plan that is freezing is just over $1 million. Many larger employers, however, are consolidating all retirement plans with one service provider as a way to keep their DB plans. Among DB plans [using our] plan services, the average funded status is 83% (Figure 7, page 12). Seventeen percent of plans are at or above 100% funded status. One way to measure a plans funded status is to compare the actuarial value of plan assets to the Retirement Protection Act of 1994 (RPA) current liability. The RPA current liability, for plans complying with ERISA, is the present value of accrued plan benefits based on the interest and mortality rates 11

Figure 7. Average Funded Status of Defined Benefit Plans, 19992005

1999 2000 2001 2002 2003 2004 2005

91% 96% 93% 87% 83% 85% 83%

Source: The Principal Financial Group, March 20, 2007

prescribed by the RPA. The average RPA current liability funded status is 106% for DB plans [using our] plan services. The average RPA current liability funded status was at its highest in 2002 at 114%. Plans with a funded status below 90% are subject to an additional funding requirement. Nonqualified Plans Eighty-five percent of those surveyed favor a DC deferred compensation plan, while just 41% offer a DB-type of program. The DB deferred compensation plan is typically found in companies that offer a qualified DB plan. [Of] 3,400 nonqualified retirement plans and over 36,000 participants, over 60% of participants are in

nonqualified DC and nonqualified DB plans. Based upon the number of plans [we service], slightly over half are Bonus and Split Dollar plans. Because these plans are designed to cover a select number of participants within an organization, they represent only 14% of participants. The remaining nonqualified plans are 457(b) and 457(f) plans, which make up 11% of all nonqualified plans and 24% of nonqualified plan participants. [We analyzed] data for the 2005 calendar year, collected from approximately 30,000 full-service retirement plans and 2.4 million participants. The 16-page survey report is available online. Web site: www.principal.com/about/news/documents/ 2007totalview.pdf I
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