Since defined contribution plans — like 401(k) and 403(b) plans — have taken the place of guaranteed retirement income provided by workplace-sponsored defined benefit plans, it may be time to redesign them.
Joel Lieb, director of advice for defined contribution at SEI Institutional in Philadelphia, says that since 401(k)-type plans were not originally designed to be the sole source of retirement funding for workers, it may be time to upgrade them so they serve a more similar purpose to DB plans.
In a recent survey of plan sponsors, SEI found that the majority are not confident their employees will have enough money saved up to live comfortably in retirement, and nearly the same amount admitted that the DC plan was not designed to be the primary retirement vehicle for workers.
When employers were asked what they should do about the retirement crisis, 87% said that employees needed to save more to address the shortfall. Only 20% felt that the employer should contribute more to their workers’ retirement accounts.
“When we have a conversation with plan sponsors, sometimes they have the mentality that it is the employee’s responsibility, not the employer’s,” Lieb says. That’s when Lieb and his colleagues ask plan sponsors what the impact will be on their business if their employees can’t afford to retire. A whopping 88% said that employees choosing to work longer would have a negative impact on their business, due in large part to higher healthcare costs.
So how can plan sponsors redesign their plans to make them more effective savings vehicles and ensure that workers are able to retire when they want to?
Lieb recommends that plan sponsors examine their main goal for the retirement plan and then assess whether the plan is accomplishing it or not.
“All the information is readily available today from the recordkeeper to do this analysis,” he says. The information will help the plan sponsor determine what the plan’s retirement income shortfall is and the plan participant’s income liability.
“Generally, we recommend that you segment your employees and understand if there are issues or concerns within certain segments” and then see how those apply to the overall plan liability, he says. “Then it is easy to determine what changes need to be made to the plan to move toward the goal and objective you established.”
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To be an effective analysis, plan sponsors must evaluate the plan investments and the plan participant data at the same time. Many retirement plan committees have specific individuals focused on one aspect of the plan, like investments or HR data, but the only way to get at the main goal of the plan is to look at all of the data at once.
Plan sponsors must have a plan and stick to the plan, says Lieb.
Increasing deferral rates and implementing auto escalation are two ways to increase the effectiveness of a DC retirement plan. There is a breaking point where employees will stop allowing their contributions to be increased. Lieb says that once most accounts reach 10% deferral, participants tend to start reducing them again.
The good news about defined contribution plans is that employees are not forced to stay at those predetermined levels once they reach a certain point in their retirement savings, Lieb says.
“Company matches are critical,” he says. Companies should look at what their current deferral rates are and whether or not it makes sense to stretch the match to promote additional savings or increase it if it is not at industry standards.
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Another way to make defined contribution plans more like defined benefit plans is to implement a custom lineup of investments with a mix of passive funds and institutional multi-manager active strategies. If companies are too small to have an investment committee, they can take advantage of an outsourced 3(38) advisory service where they can hire a fiduciary to help them with the pieces they are uncomfortable with managing.
Re-enrollment to a qualified default investment alternative, like a target-date fund, is also key, Lieb says. By going back and sweeping up employees who never opted into the retirement plan, a company can get its participation rate up.
“Default vehicles are a great way for plan sponsors to set them on a better path,” he says. They offer well-diversified and balanced portfolios and they make it easier to monitor an employee’s progress as they move forward.
He points out that this is not a one-time initiative.
“If you are going to go through this process, you should do an evaluation of your goals annually. It will help determine if you are on track. If you are not on track, what are the areas of concern?” he says.
Once you have an idea of where the shortfalls are, you can address them.
“We have to, as an industry, alleviate the fear of plan sponsors that if they try to do too much that they set themselves up for potential liability,” Lieb believes. “The hardest thing for us is the litigation that is out there stifling innovation. The last thing you want to do for those who only have a DC plan as a retirement vehicle is to not put your best thinking forward.”
