I have probably been receiving them for years, but lately I have noticed opposing position papers in my inbox. Some claim Americans need a revival of defined benefit (DB) plans because of a looming retirement crisis, while others contend that defined contribution (DC) plans are doing great and there is no cause for alarm. DC plans do not define benefits in retirement, and DC accounts are personal. Therefore measuring average performance or aggregated account values, to assess the effectiveness of the DC system has limited utility for an individual. Harry Truman said, “It’s a recession when your neighbor loses his job; it’s a depression when you lose your own.” Similarly, everyone may be doing great in their DC plan, but if you have not saved enough and formulated a prudent withdrawal plan, retirement may feel like a depression. On the other hand, if you are a diligent saver and earn good returns, your retirement lifestyle may be better than it could have been with a DB plan.
In other words, the distribution of outcomes across DC plan participants tends to be more dispersed (has fatter tails) than the distribution of outcomes across DB plan participants—because DB plans define their outcome formulaically. To use a financial analogy, you might say DC plans are more stock-like while DB plans are more bond-like. The key for individuals is recognizing that many DC plans offer enough flexibility to create a more DB-like experience.
The S&P STRIDE Indices measure the performance of such a strategy, although there are many ways to accomplish similar aims depending on the available investments within given DC plans. The vital step to creating a more DB-like experience from available investments within a DC plan is lowering the risk to the future income expected to be drawn from the DC account.
Innovative plan sponsors are aware of the hurdles that participants face, which include not only saving and investing prudently, but also managing an effective withdrawal strategy in retirement. The title of Thomas Heath’s Washington Post column, published April 20, 2019, succinctly expresses the decumulation challenge. “Saving for retirement is hard. Knowing how to spend it down is harder.” Mr. Heath noted some of the challenges of retirement funding by quoting my colleague Howard Silverblatt and contemplating his own situation as he looks ahead to retirement. The DC system is essentially a collection of privately run investment menus from which individuals must handcraft their own retirement funding experience. Each sponsor should recognize the enormity of such a challenge and make income risk management solutions available to their participants. Each individual participant must develop their own situational awareness to inform their decisions about long-term accumulation, income risk management, and ultimately prudent decumulation. Relative to bond-like DB plans, there will be winners and losers. That is the nature of the DC system.