News, Analysis, and Research for the Retirement Planning Industry

Designing The Ideal DC Plan

In DC plans, Plan Sponsors, Research on 16 November 2010 at 1:03 am

All too often, “market research” consists of asking pretty much the same old questions to pretty much the same people, and reporting that the difference between “strongly agree” and “strongly disagree” was pretty much the same as the last time.

Kudos to Northern Trust for taking a more creative approach in their study released earlier this month.

“The Path Forward:  Designing The Ideal Defined Contribution Plan” was based on detailed interviews conducted with 50 large DC plan sponsors representing more than 970,000 participants and $100 billion in assets and 5 leading investment consultants.  The open-ended question that formed the basis for the discussion was “How would you design the ideal workplace DC plan if you were freed from existing laws, structures, history, and standard industry practices.”  Here are a few of the findings I found particularly interesting:

  • Who calls the shots? : The five investment consultants thought plan sponsors should take a more active role than what plan sponsors were generally willing to assume.  Perhaps frustrated by low participation and deferral rates, the investment consultants “consistently expressed a desire to take critical decisions out of the hands of plan participants altogether.”  Plan sponsors viewed these suggestions as “excessively paternalistic” and expressed a desire to instead to provide resources to “allow employees to make informed decisions about what is best for them and their money.”
  • Like gym class, everyone has to play:  63% of the plan sponsors and 4 out 5 investment advisors (not thought to be related to the renowned “5 dentists”) thought DC plan participation should be compulsory.
  • Give ‘till it hurts: Though about 2/3 of sponsors thought the default level for salary contributions should be between 3% and 6%, “one consultant noted that ‘10% of salary is not enough to reach a full replacement benefit ratio. Auto escalation enables people to make a decision today to save more in the future.’   This sentiment led several consultants to suggest use of auto escalation up to 15% of salary.” Further, all but 3 sponsors opposed restrictions on maximum post-tax contributions.
  • Sponsors’ willingness to accept an increase in costs:  60% of sponsors believed employer contributions should vest immediately.
  • Conflicting views on target date funds:  Though almost 80% of sponsors felt target date funds represent the best QDIA, the survey acknowledged their hazards.  It quoted one plan sponsor has saying that “target date funds ‘do a tremendous disservice’ to plan participants.  ‘They are totally misunderstood by participants.  They don’t have similar advice paths, they don’t have any benchmarks and there are no comparisons.’”
  • Biggest half-a-surprise:  4 out 5 consultants favored automatic rebalancing for all DC participants (no surprise given the first bullet), but 76% of plan sponsors did as well.  I found this surprising given concerns about being paternalistic. It also sounds like an opportunity for potential legal exposure if participants think they were rebalanced right out of some upside (or into downside).

Not surprisingly, there was a desire for more advice and educational opportunities for participants.  One sponsor commented that “[t]here’s an opportunity to offer a more holistic approach to advice.  We try to get them to invest, but we don’t often put that in the broader perspective of how their investments sit in their financial planning picture overall.”

Plan sponsors and their DC plan providers have to serve participants whose investment knowledge ranges from those who really don’t know exactly what a mutual fund is, to those who enjoy actively managing their portfolios.  Providing access to educational materials, planning tools, and advice that is valuable to everyone on the spectrum, but not so comprehensive that it becomes overwhelming, is no easy task.  In a discussion as to how to approach the number investment options, a participant made a suggestion that I thought was equally applicable to the education and advice challenge.

Research has shown too many investment choices reduces DC plan participation rates (here is a good article on consumer choice in the current issue strategy+business that happens to mention one such study).  Plan sponsors must balance simplifying the investment selection process so that novice investors will participate, and giving more experienced investors the flexibility to meet their needs.   One participant suggested how a plan could satisfy everyone by using “three doors.”

“The ideal plan would have three doors.  The first door would be a balanced/target date fund.  The second would enable the employee to set up his or her own investments from a menu of not-too-complicated options from broad categories…The third door would be a brokerage option in which employees could buy individual stocks and use individual managers.”

To be sure, this “three door approach” would require a robust offering from the provider and a particularly high level of commitment on the part of the plan sponsor, but by giving participants access to the investments most likely to maximize each persons participation (along with the appropriate educational tools and advice) maybe the DC plan, could be (almost) all things to all people.

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