With corporate America continuing to phase out traditional pension plans, employers and employees are becoming painfully aware of the shortcomings inherent with defined contribution plans that most companies now offer in place of traditional pensions, according to a new issue brief by the Institutional Retirement Income Council. IRIC, however, says all is not lost as companies can now apply lessons learned from defined benefit plans to improve the retirement outcomes for participants in the next generation of DC plans.
The ongoing shift from defined benefit to DC plans has prompted the financial services industry to rapidly develop products that deliver a steady stream of retirement income, one of the biggest shortcomings with DC plans. While numerous retirement income products are hitting the marketplace, employers and regulators are grappling with how they fit within qualified retirement plans. Additionally, employees have yet to embrace retirement income products, including those embedded in retirement plans focused on generating secure retirement income.
“The industry, especially plan sponsors, is in a terrific position to help shape the next generation of DC plans,” says Martha Tejera, founder of Tejera & Associates, LLC and an IRIC member who authored the issue brief. “While it may be tempting to wish for a return to the good old days when defined benefit plans reigned, that’s just not realistic. Many companies phased out their DB plans for valid reasons that still exist, including unpredictable and volatile minimum required contributions, benefits which aren’t very tangible to employees and a byzantine regulatory environment.”
The brief discusses the importance of certainty, noting that employers’ inability to reliably predict required minimum contributions from year to year was a chief factor in the downfall of DB plans. The brief states that certainty is similarly important to individuals and that the next generation of DC plans needs to provide investment options that offer both certainty and the ability to pay a predictable retirement income for life.
The issue brief also discusses other lessons that can be learned from DB plans. For example, retirement benefits need to be tangible to employees and easily understood. And, future government regulations should encourage employers to adopt retirement income solutions that ultimately lead to healthy utilization by employees.
“Most employees favor defined contribution plans because they are easy to understand. That means retirement income products need to present their value in a way that is simple and easily understood to make the benefit tangible to employees,” said Tejera. “Today’s workers also expect to take their retirement savings with them when they switch jobs. Therefore, the next generation of DC plans needs to continue to support portability through all phases of employment.”
The brief noted that in its efforts to shore up the funding status of DB plans, regulations made contribution levels more volatile and unpredictable. The unintended consequence was to discourage employers from sponsoring DB plans and replace them with DC plans. One example was the Pension Protection Act which encouraged employers to incorporate automatic features into their DC plans.
“If retirement income options are structured in a way that provides tangible benefits to employees, and regulations are adopted that encourage employers to offer retirement income options in a way that maximizes utilizations, the end result will be a win-win for employers and employees,” says Tejera.
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