What about the investment option offering?
Some sponsors believe that offering a wide array of investment options is beneficial to members. Certainly, a reasonable stable of options spanning the investment horizon is helpful. But offering too many choices can confuse members, particularly when there are multiple options with the same risk/reward profile.
If choices are too complicated, members may simply select the default option. In some cases, members may select an equal weighting in all funds offered—either because they cannot decide, or because they believe this approach provides maximum diversification.
Careful selection of the investment fund line-up and effective communication are integral to ensuring that most members will select appropriate asset mixes. Think of it as a spectrum. On one side, for plans with less enthusiastic (or sophisticated) investors, a series of target date funds may be the answer. More engaged members may appreciate being able to select an asset-allocation fund that meets their current risk profiles. On the other end of the spectrum, highly sophisticated investors may be able to manage their own asset mixes by using very low-cost investment options or even exchange traded funds (ETFs).
Figure out where most of your employees are in this spectrum and design your line-up accordingly. Don’t overbuild.
Maximizing retirement options
The ultimate goal of the DC plan is to provide a retirement income, typically a substantial portion of a total retirement income. Unfortunately, when members actually get to retirement, the options available may be very expensive and may not provide the protection needed. Most retail products have high fees and expenses, reducing the amount of retirement income available.
Members do not always realize the risks associated with living longer. With maximum withdrawals, the typical life income fund (LIF) product is expected to deplete most or all of an individual’s retirement assets by the time they reach 85. Most 65-year-olds are expected to live for at least 20 years. Many will outlive their money. Life annuities protect against this risk but are high-cost options, especially if inflation protection is included.
Some DC plans have started offering self-annuitizing or LIF-style income options directly from the DC plan. If designed properly, these investment options can significantly reduce the expenses otherwise payable in the retail environment while offering significant protection against retirement income risks. But this is not a simple process. Not all recordkeepers can accommodate these approaches and the sponsor must clearly understand its risks and responsibilities before it offers these valuable options to retirees.
Measuring your plan’s effectiveness and moving to the next level
You want to help employees plan for retirement and that members want to ensure they’ll be ready for retirement. You need to measure our progress in achieving those goals and change what is needed in order to reach them.
You can start by calculating the percentage of employees who will meet or exceed some target total replacement ratio based on selected contribution rates and investment options. Include the expected income from government programs. In the Canadian context this is probably somewhere around 60% of gross pre-retirement income. This assumes members have managed their debts and have access to provincial healthcare plans.
Next, assess where the shortfalls are and why they exist. Are they appearing for members earning significantly more than the wage base covered by government programs? If so, would an integrated contribution rate help? Are members under-contributing, investing too conservatively, or both? Would communication strategies work best, or are modifications to the auto features or basic plan design needed?
You can then calculate the percentage of members whose asset mix is within deemed acceptable limits considering their investment horizons. Again, will communication strategies be effective in addressing any shortfalls, or are design changes needed?
Calculate the percentage of members whose asset mix will be too aggressive by the time they reach retirement age, assuming they don’t actively change it. You can then assess whether members will actually make changes by periodically reviewing the statistics from the DC recordkeeper on the number of investment changes made by members, the number of inquiries about investment considerations, and the usage of recordkeeper tools. A high ‘apathy rate’ may be a sign to consider target date funds.
Finally, consider the impact lower-cost retirement options could have.
Taken together, you can use the three design levers—contribution rates, investment options and retirement options—to increase the odds of retirement success.
Todd Saulnier is a Senior Associate with Mercer’s investment consulting business in Halifax.
1 Note: for sponsors operating group RRSP arrangements, participation requires that a member complete the enrolment application form that complies with the Income Tax Act.
2 A note of caution: Some recordkeepers’ rebalancing processes may result in the premature sale of guaranteed investment certificates, thereby causing market value adjustments. The actual terms of the rebalancing features must be understood and appropriately communicated to participants before using.
3 For example, at the moment, several recordkeepers use the current asset mix in calculating the expected future investment returns in calculating a participant’s projected retirement income. The recordkeepers tools should instead take into account the automatic changes to the asset mix in calculating the future expected returns.