A Framework for Offering Income in DC Plans

According to the latest Department of Labor statistics, more than 640,000 employer-sponsored defined contribution (DC) plans are in existence in order to help nearly 90 million participants prepare for retirement.[1] To date, traditional measures of success included factors based on a plan’s inputs, such as participation rates, savings levels, and the relative performance of underlying investment options. Measuring these input-focused metrics may not, however, accurately capture a plan’s potential to provide its participants with retirement income adequacy (a common goal for most participants).  The Defined Contribution Institutional Investment Association (DCIIA) addressed this concern, creating a best practices framework[2] for plans with an objective of retirement income adequacy.  Key takeaways highlighted for plan sponsors include a need for updated plan design, an outcome-based Investment Policy Statement and new benchmarks for plan success.

Plan Design

When it comes to investment menu offerings, less may be more. While plan sponsors should seek to avoid overwhelming participants with too many options, the addition of a stand-alone income focused option may offer participants the ability to target a desired standard of living in retirement while concurrently signaling the need to consider income as a planning goal.  Research has shown that many American workers – even those approaching retirement – lack even a rudimentary retirement plan.  Of those who do have a plan, most plan a mere five years into retirement, rather than a far more likely retirement time horizon, such as 20-30 years.[3]   Now is the time for plan sponsors to evaluate the variety of available options and choose the arrangement that best suits their plan demographics.  Placing such an option alongside a conventional target date series, for example, may not only help participants plan for retirement income but also emphasize the importance of doing so!

Focusing on Outcomes

When evaluating the success of a retirement plan, sponsors should consider output-focused metrics, such as income replacement ratios by employee cohort.  An income replacement goal that takes employee demographics into consideration (such as salary) might be an appropriate metric for plan sponsors to consider.  One of the few studies that discuss replacement and savings rates by income cohort is by Massi De Santis and Marlena Lee[4]; the findings of which can be useful when designing an outcome-focused Investment Policy Statement (IPS).  Taking this step helps lay the foundation for what many plan sponsors are focusing on; the ability to better evaluate the success of an income focused default option and the plan as a whole.

Benchmarking Success

Many tools, such as the S&P Shift to Retirement Income and Decumulation (STRIDE) Index Series, which can serve as a benchmark for income-focused retirement strategies, are available from service providers to assist with this evaluation. It can also be important for sponsors to incorporate additional sources of income tools, such as Defined Benefit and Social Security payment estimates, to provide a more complete picture of participants’ sources of retirement income.

Measuring retirement readiness not only helps gauge the overall effectiveness of a DC plan, but it also helps identify at-risk employee populations that may require further attention to increase the likelihood of adequate retirement savings.  Focusing on income as the outcome is an important first step in helping participants meet their replacement income goals; effective progress means continuing to evaluate new income-focused solutions, improving plan metrics and utilizing relevant benchmarks to measure success.

 

4 Massi De Santis and Marlena Lee, “How Much Should I Save for Retirement”, Dimensional Fund Advisors, June 2013.

The S&P STRIDE INDEX is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”), and has been licensed for use by Dimensional Fund Advisors LP (“Dimensional”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Dimensional. Dimensional’s Products, as defined by Dimensional from time to time, are not sponsored, endorsed, sold, or promoted by SPDJI, S&P, Dow Jones, or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such products nor do they have any liability for any errors, omissions, or interruptions of the S&P STRIDE Index. Dimensional Fund Advisors LP receives compensation from S&P Dow Jones Indices in connection with licensing rights to S&P STRIDE Indices.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Dimensional Fund Advisors and Strakosch Retirement Strategies are unaffiliated entities.

This article is offered only for general informational purposes; it does not constitute investment, tax, or legal advice and should not be relied on as such.

[1] U.S. Department of Labor Employee Benefits Security Administration, “Private Pension Plan Bulletin –

Abstract of Form 5500 Annual Reports,” October 2014.

[2] See DCIIA White Paper: Defined Contribution Plan Success Factors, Framework for Plans with an Objective of Retirement Income Adequacy, May 2015.

[3] Society of Actuaries, “2011 Risks and Process of Retirement Survey Report of Findings,” March 2012.

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