Holly Verdeyen, Director of Defined Contributions
Times have changed for those planning for or nearing retirement. It wasn’t that long ago that most working people could count on a retirement pension through a defined benefit (DB) plan operated by their company. With many DB plans now frozen, defined contribution (DC) or 401(k) plans have now become the primary retirement savings vehicle for many. In fact, today a DC plan is the only retirement savings plan offered to 71% of private-sector participants.1
This puts pressure on both employees and DC plan sponsors to get the plan right. The stakes are high. For example, a study conducted by AON Consulting and Georgia State University notes that most people will need a retirement income equivalent to about 78% of their current income.2
DC plans are evolving to meet that challenge. During the 1980s, DC plans were pretty bare bones—a basic 401(k) with limited fund options—and essentially a hands-off attitude to employee participation. That evolved in the 1990s with plans that offered participants a wealth of choices. That backfired to some extent as many participants were overwhelmed and lacked the investing knowledge to select the best option for them from among the many options.
During the 2000s, we’ve started to see a more nuanced approach. Some plan sponsors have been looking to move away from the historical approach of filling up lineups with name-brand, single-manager funds, which are oftentimes proprietary funds for the recordkeeper. They're looking to move to a more institutional approach of white label funds, open architecture, multi-manager solutions. Some participants now elect to take a "hands-off" approach and invest in something like a target date fund, with the plan sponsor handling the details. Others may want more of a “manage it with me” approach from the plan sponsor, in which they still retain some investment decision-making. A minority of participants may have the skills and desire to access something like a brokerage window, where they can design their own plan.
The trouble is, as DC plans have grown in sophistication, many plan sponsors no longer have the resources, scale or expertise to properly manage them. That’s in part because with the decline of DB plans, many companies now lack the skills to properly tackle pension funds. Moreover, managing DC plans demands time and resources, two things often in short supply within the HR department or other parts of an enterprise given the demands of managing a DC plan. That leads them to search for outsourcing partners who can take on a discretionary role to implement such solutions. Also, sponsors are looking for support in selecting and monitoring vendors, such as the recordkeeper's support in delivering participant communication efforts.
In this environment, I see three key things that DC plan sponsors need to target to provide participants:
Design a plan with the right objectives. That may seem obvious, but it really isn’t. The goal of a DC plan, ideally, should be to do all that it can to ensure participants a secure retirement. We believe income replacement is the right objective for a defined contribution plan. Plan sponsors, given their participant demographics and total company benefits, should develop a Target Replacement Income (TRI) goal for the plan, and design the plan auto-features, default option and company match rate with the target replacement income goal in mind. On an ongoing basis, the plan should provide participants with a gap analysis disclosure or a statement with retirement income projections as part of their standard reporting to help participants better understand their retirement readiness. As we learned in the 1990s, too many choices can be a bad thing. Research in behavioral finance over the past few years has shown that an abundance of options can lead to bad decisions. So, keep it clean and simple for participants.
Because knowing what each individual need for a secure retirement can be a daunting task, many plans simply have a goal of maximizing the plan participation rate or meeting a particular savings rate. While these kinds of goals may seem sound, they won’t necessarily help participants achieve the income replacement that they need.
Get the default options right. Default options matter. They do much to determine the long-term success of plan participants in reaching their retirement goals. One part of this is to get the correct default for new employees, requiring them to opt-out of a DC plan rather than opt-in. Also, plan sponsors will want to choose a qualified default investment alternative (“QDIA”) with an investment objective that mirrors that of the DC plan – income replacement – and target a high percentage of participants in the QDIA. Plan sponsors may also consider a re-enrollment campaign to provide participants the opportunity to either re-select their investments, stay with their original allocation, or be moved into the plan’s QDIA. The worst outcome is to leave participants who don’t appear to have an age-appropriate asset allocation where they are, and to use automatic enrollment for new participants but not automatic re-enrollment for long-time employees.
Consider hiring a partner. Developing a DC plan that offers the right options to meet carefully chosen objectives is more difficult than using an exhaustive set of “good enough” options, reporting to participants their performance and plan balance, and then calling it a day.
For that reason, bringing on board a DC plan outsourcing partner may be one way a plan sponsor can relieve themselves of some of the work. A partner can help plan sponsors figure out the best design for a plan, while exposing it to a larger set of asset classes and helping sponsors meet their fiduciary responsibilities. The net benefit to the plan sponsor is the first class strategic advice they seek together with often meaningful cost savings, improved diversification, and better fiduciary protection on the strategies in the fund line-up.
Here at Russell Investments, we have a long history of helping DC plan sponsors do the best for their participants. To learn more, visit our section dedicated to DC plans.
1 "Employment-Based Retirement Plan Participation: Geographic Differences and Trends, 2013," EBRI, 2013.
2 "Replacement Ratio Study," Aon Consulting and Georgia, 2008
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First used: June 2016