At a time when more employers are finding it difficult to fund DB plans and many workers lack the financial acumen to successfully direct their DC plans, Mercer is calling for a new middle-ground solution: target benefit pension plans, which aim to provide a target income in retirement but do not guarantee it.
“Target benefit plans can define fixed contribution requirements or contribution requirements that vary within a reasonable age,” a new Mercer communiqué explains, referring to these plans as “a lifetime pension funded with fixed contributions.” The contributions can be provided entirely by the employer, or they can be shared by the company and the employees. This provides cost certainty for firms, according to Mercer.
Another advantage of target benefit plans is that the retirement savings are invested on a pooled basis by professional money managers, rather than by individual plan members, leading to better investment performance and lower management fees, according to the communiqué.
Target benefit plans are also a better solution to the financial risk posed by increasing longevity, Mercer argues. The longevity risk is pooled among all plan members, removing the pressure from individuals to manage their personal risk of living longer.
While target benefit plans are susceptible to the same risks that threaten DB and DC plans, their design is such that the risk can be distributed in an efficient way, according to Mercer.
The reason for the flexibility of target benefit plans is that although they intend to deliver a target income, they don’t guarantee it. So conditional benefits such as future indexing can be eliminated temporarily if the plan doesn’t have enough assets to provide these benefits. These plans can also reduce accumulated benefits for both active and retired members in tough times and then increase them when the climate improves, Mercer explains.
The key to making target benefit plans sustainable in the long run is to ensure that contribution rates and benefit levels do not remain static, according to the communiqué.
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