We are optimistic that a bright future lies ahead for retirement, despite all the concerns that Americans feel today.
Last week, I wrote about the vanishing American dream of a secure retirement. But it doesn’t have to be this way. There is a way forward that can restore confidence in retirement.
Learn Our Lessons
History holds some important takeaways for plan sponsors, advisors to plan sponsors, and asset managers who seek to provide a better road to retirement:
- Change is inevitable: an aging population means more retirees; retirees will increasingly rely on defined contribution (DC) plans; and regulations will continue to evolve. Only DC plans that have flexibility engineered into them can succeed over time.
- For DC plan participants, offering more choice sounds terrific in theory but is failing in practice. Providing good default options gives most DC participants better outcomes.
- Legacy defined benefit (DB) pension systems have had some very solid notions—such as guaranteed lifetime income and risk pooling—that we should strive to capture, even as we strive to avoid past systems’ shortcomings.
Give Participants What They Want
What do DC participants want for their retirement?
Two-thirds tell us they want a steady income stream. In other words, participants’ top demand is a pension in their DC plan.
Next, participants want principal protection.
Third, participants would like to preserve ready access to their money.
Having a choice of attractive investment options was fourth on participants’ wish list—even though it probably consumes most of the time that plan sponsors devote to managing their DC plans.
Create a Better Future
Do DC plan sponsors have to rip everything up and start from scratch? Not at all.
Our recommendation is to create a qualified default investment alternative (QDIA) that is managed with the same due diligence, investment focus and cost sensitivity with which DB plans have long been managed.
Then, the DC plan should guide participants into the default through auto-enrollment and auto-escalation. Participants who value freedom of choice can always opt out of the default and into whatever options they prefer.
For larger plans, the QDIA can be customized to the plan’s specific objectives and demographics. Open architecture ensures the ability to mix and switch out assets, strategies and asset managers over time.
A plan default that meets today’s needs but adapts as those needs change gives participants the comfort of knowing their retirement plan will still be right for them down the road.
Finally, adding lifetime income to the QDIA can make a DC default option into a pension. We recommend our multi-insurer design that provides a secure income stream to employees for life, while providing greater flexibility and protection for the sponsor.
Assess the Benefits
The next-generation DC design can provide participants with better outcomes and more control. Particularly if the default includes lifetime income, participants no longer need to struggle with almost impossibly complex planning problems.
As a result, participants can focus on the things they can control: how much to save and when to retire.
For plan sponsors, next-generation DC design can provide a better employee benefit with greater flexibility and less risk.
And that, to us, can create a new kind of social contract between DC plan sponsors and participants—one that can be more sustainable over time.
We believe that this is the way forward to restore retirement security. After all, isn’t a secure retirement part of the American dream?
© Alliance Bernstein