How (and why) employers are reinventing DC plans
Since companies began moving away from defined benefit pension plans, employees have had to fend for themselves when it comes to retirement savings and planning. And while most industry experts agree that DB plans are not coming back, the next push is to make defined contribution plans, like 401(k) and 403(b) plans, more like DB plans.
Also read: More firms freezing, closing DB plans
Russell Investments takes a deep look at the Form 5500 filings every year to determine how DB plans in the aggregate perform relative to defined contribution plans.
“Obviously, each year the return is different, mainly because the asset allocation between them both is different,” says Bob Collie, chief research strategist for Russell Investments’ Americas Institutional business. For the most part, DB plan returns are better than DC plan returns — but why?
Collie says there are three main reasons for that: asset allocation, fees and the decisions made by individuals within the DC system.
DB plans have more fixed income than DC plans, so every year equities perform better, DC plans do better.
“That’s the main driver short-term,” he says. In the long-term, higher fees take a toll on DC plan revenue. That is mainly because individuals are paying for additional services and more personalization of their accounts than is available in DB plans. DB plans have a fee advantage, Collie says. That gap will close eventually as more DC plans look for lower fee options.
DC plan participants have more control over their retirement plan assets than those who have DB plans, he adds. That can cause problems, especially when it comes to market timing. Many people see investments go up and buy in at that time. The same goes for when investments go down. They sell. That can be an expensive mistake for plan participants.
As more plan sponsors include target-date funds and other managed accounts in their plans, DC plan returns will improve relative to DB plans over time. These professionally managed asset allocations take the market timing aspect out of the equation.
“As we move from defined benefit to defined contribution, we are seeing lower returns. That is cause for concern at the public policy level,” Collie says. “When that translates to the individual plan level, it is a concern for plan sponsors.”
Defined benefit plans have always been more paternalistic. And even though most plan sponsors want to do what’s best for their employees, in a defined contribution plan that may mean a small contribution to the plan but not having any responsibility for the outcome of that investment.
“The incentive for plan sponsors to make the changes we are talking about is not quite as pressing as it is in the defined benefit system, where every dollar earned in the investment program is a dollar less [employers] have to contribute,” he adds. In the DC plan space that is not how it works. Even though plan sponsors are a responsible community of people, they don’t have that pressing incentive to make changes that maybe need to be made to the DC system to make it work as well as it can.
Many plan sponsors have introduced automatic enrollment, automatic escalation, a qualified default investment alternative like a target-date fund or managed account. All of these things help employees save for their futures, even if they are not motivated to do it on their own. Adding lifetime income options to DC plans is the next push. Many in the industry have spoken about this option for years, but it is only recently that plans have begun acting on it.
“At this point in time, there are three or four legislative strands pulling in different directions on that. Definitely the degree of saving in aggregate is too low,” Collie says. “The main area of focus on that is among people who don’t have any plan at all, not around ‘are people in plans saving enough.”
Many small companies don’t have a retirement plan option. That’s where the myRA, state-level plans and multi-employer plans can help meet the need.
“In some ways, there has been progress made and in other ways, it has been slower than one might have hoped,” Collie says. “You can’t complain things aren’t perfect if they are moving.”
He believes that plan sponsors should encourage employees to move to professionally managed assets and educate them about contribution rates. Expanding coverage to additional workers also would improve retirement security.