Alongside the steady decline of defined benefit pension coverage in Canada, defined contribution plans have seen a massive growth — “a secular shift of responsibility onto the individual when it comes to retirement security in Canada,” according to Preet Banerjee, a personal finance expert, during Benefits Canada’s 2022 DC Investment Forum in late September.
He called on DC plan sponsors to simplify plan enrolment and asset allocation for members in recognition of their financial overload and use behavioural finance principles to help them meet their retirement income goals.
One of the simplest things DC plan sponsors can do to boost member participation rates is to increase their match amount, said Banerjee, noting multiple studies from his literature review of DC pension plans around the world found that for every 10 percentage point increase in a plan sponsor’s match rate, there was a participation rate increase of between two to 6.3 percentage points.
A higher employer match can also play a significant role in boosting plan members’ contribution rates, he said. One study of a DC plan sponsor found that when the company increased its match rate for union and management staff by two percentage points, employees boosted their own contributions to take advantage of the new higher match.
Referring to a study on organ donation, Banerjee demonstrated the value of adopting automatic enrolment in DC plans. One study compared countries with opt-in organ donation regimes — where citizens had to actively choose to be an organ donor — and those that automatically made every citizen an organ donor but allowed them to opt out. In opt-in countries, organ donation rates were 28 per cent, while opt-out countries saw close to 100 per cent organ donation rates.
The effect is similar with DC plans, he said, noting a study found that close to 99 per cent of plan members in auto-enrolment plans made a contribution to the plan in their first four years, while opt-in plans reached about 71 per cent.
While the tendency among some DC plan sponsors with auto-enrolment is to set the contribution rate lower to avoid plan members choosing to opt out, Banerjee noted studies have shown that a higher contribution rate doesn’t correlate to plan members dropping out of the plan at a higher rate.
“If you’re worried about retirement income security of people that are in your employ, consider, if you’re using defaults, setting those defaults higher and have them opt out of that as opposed to setting them lower, because they’ll stay at that lower amount and that might not be enough for them to have a secure retirement.”
He also suggested that plan sponsors pay particular attention to their default investment options given plan members’ entrenched status quo bias. Plan members perceive the default option as having their employer’s implied endorsement, which can have a negative impact on employees’ retirement security if the fund is too conservative in nature.
Banerjee also cautioned against too many investment choices. His literature review found one of the most common factors impacting participation and contribution rates and the asset allocation decisions of plan members is an “overload” of financial decisions. Faced with numerous investment options to evaluate, plan members are less likely to finish enrolment in the plan. One study found that for every 10 additional funds on the platform in a DC pension, the participation rate decreased between 1.5 to two percentage points.
He advocated for adding a quick enrolment option to an auto-enrolment plan. Rather than forcing plan members to pick their contribution rate and asset allocation, a quick enrolment presents them with an ideal default fund and contribution rate and allows them to select yes or no, with those who want more options having the opportunity to investigate further. Plans with this option saw plan participation rates increase 10 to 20 percentage points, he said.
Read more coverage of the 2022 DC Investment Forum.