Improving DC benefit adequacy

The year 2013 resulted in fantastic news for DC plan members: great returns from most asset classes and increases in interest rates, translating into both larger accumulated savings and better expected retirement income levels—particularly for those planning to purchase a life annuity.

While 2013 was an exceptional year, long-term return expectations remain below what they were pre-2008. So as more and more DC members get closer to retirement, a number of DC plan sponsors are increasingly worried that their plans may not do enough to help members retire with sufficient income.

Contributing enough?
When broaching the benefit adequacy topic with clients in the last few months, most reacted with one or more of the following comments:

  • “We don’t need a study to understand we’re not contributing enough to fund our employees’ retirement”;
  • “Our budget does not allow us to increase our contributions”; or
  • “As long as we’re competitive, no change needs to occur.”

These are all good points. However, they only look at one side of the equation: employer contributions. And most sponsors—rightfully so—believe they’re not responsible for fully funding their employees’ retirement. But there are other aspects of your DC plan that directly impact a member’s retirement success. The good news is that making powerful improvements to these aspects does not require spending a lot.

Making your DC plan more effective
Before entertaining the idea of increasing employer contributions, you should look at how you can optimize your current plan. Here are a few ideas to boost DC plan effectiveness.

Maximize employee contributions
First, if your contribution formula is a matching scheme (by far the most popular approach in Canada), it’s unlikely that all employees are taking full advantage of potential employer contributions. Obviously, improving take-up on employer matches does increase actual employer cost. But that would be in respect of the formula already in place.

Push communications aimed specifically at those leaving money on the table have proven to be very effective at nudging them into action. Another strategy is to set the default employee contribution rate to maximize the employer match, putting the onus on the employee to opt out or down. Auto-escalation of employee contributions is another smoother way to gradually increase member savings, again with the possibility for them to opt out or down.

Second, you may wish to review your contribution formula altogether to increase total (i.e., employer plus employee) contributions. This is important, as studies show that few employees contribute over what is required to earn the maximum employer match. For instance, a base, unmatched employer contribution does not fully leverage employee savings, as it represents “free” employer contributions. By requiring an employee contribution for every dollar of the employer’s, you are increasing total savings. As an example, consider the following contribution formulas (expressed as % of covered earnings):

Contribution segment

Unleveraged

Leveraged

Super-leveraged

Unmatched employer base

2%

0%

0%

Employee contribution range

0% – 3%

0% – 5%

0% – 7.5%

Employer match on above

100%

100%

66%

Maximum employer cost

5%

5% (unchanged)

5% (unchanged)

Total (employee + employer)

8%

10%

12.5%

An analysis could also be performed to determine the necessary overall savings rate required to likely attain a targeted income replacement ratio at retirement. The contribution formula would then be modified accordingly.

Improve investment outcomes
Target date funds (TDFs) and lifecycle portfolios have essentially become the norm for new plans and are increasingly adopted by existing plans reviewing their option lineup, to the benefit of an overwhelming majority of plan members. Off-the-shelf solutions are gradually evolving in the right direction (see my previous on this subject), but more sophistication still remains desirable.

Custom TDFs or portfolios are now easier to execute and allow for critical improvements such as selection of best-rated managers, diversification of management styles, capitalization exposure and managers, as well as inclusion of alternative investments. All of these tend to produce better, less volatile returns.

Glide paths can also be tailored to your members’ actual needs. Why not have glide paths geared toward the type of retirement income vehicle (life annuity versus life income fund or registered retirement income fund) rather than on “risk profiles”? For example, the “life annuity glide path” could progressively immunize a member’s portfolio against interest rate movements (and, therefore, life annuity prices) by increasingly moving toward long-term bonds (instead of the now common norm at maturity of a mix of money market and medium-duration Canadian bonds…and equity!).

Communicate better
Pushing the communication envelope remains key to having members use your plan in an optimal fashion, be it to support the changes suggested above or to ensure members understand what they have to do and appreciate the plan for its full value. Simplicity and focus always represent a winning strategy.

Select a limited number of messages you want to convey each year and hit these nails through multiple communication mediums, including using new approaches available (such as mobile technology). Make all communications about members’ needs—not yours—and reap the benefits of capturing their attention!

Measure your success
All of the above are highly leverageable in that they represent relatively limited efforts and costs, while having a potential for significant impacts on how well your plan delivers for your employees. Measuring progress is the best way to understand what worked well and what did not, leading to further improvements.

These suggestions represent only a portion of what can be done. Keep looking for ways to make your plan more effective!