Millennials and the mythic DB plan
For Millennials, Gen Xers, and even the tail-end of the baby boomers,
The promise and expectation of lifetime retirement income was once a cherished part of the American dream
the idea of a defined benefit (DB) plan seems too good to be true. The promise and expectation of lifetime income once retirement kicks in was once a cherished part of the American dream. And teams of actuaries, asset managers, accountants, benefits consultants and attorneys were left with the herculean task of sustaining it all.
As the record shows, DB plans were in fact too good to be true over the long-term. In the face of mounting liabilities, DB plans have shrunk from covering nearly 40% of the private sector workforce at their height in 1979, to approximately 13% in recent years. And for the dwindling number of private DB plans still being offered to employees, the threat of insolvency is always top of mind.
DB vs. DC: Moving in opposite directions
% of US private sector workforce covered by plan type
Source: US Department of Labor as of 12/31/14
The dilemma of DC plans
For the dwindling number of DB plans still offered, the threat of insolvency is always top of mind
With the future of DB in question, the void has increasingly been filled by defined contribution (DC) plans. However, the changeover has been far from smooth due to the decided differences between the two plans. The biggest difference being that DC plans fall short of providing the certainty of retirement income that DB plans offer.
Helping to drive change is a shift away from thinking about DC as solely a savings and investment vehicle focused on reaching the 'magic number.' Increasingly, and by necessity, DC plans are also gaining recognition as retirement income generators. The DC industry, which in recent years has made great strides in investor education, would do well to expand their efforts to show employees how they can convert savings to income. Upon reaching their retirement date, an employee has any number of options for their DC savings, such as cashing out of the plan immediately, annuitizing or remaining in the plan.
TDFs: The transition to lifetime income
In an effort to help employees manage risk throughout the saving phase of their careers,
Increasingly, and by necessity, DC plans are gaining recognition as retirement income providers
DC plans took an innovative step forward with the launch of target date funds (TDFs) in 1993. Their goal was to provide a predetermined glidepath to keep pace with an employee's age and assumed risk tolerance. The concept proved so effective that TDFs were included as one of the three types of QDIA's in the Pension Protection Act of 2006. Still, without a plan for income after the retirement date, over 80% of participants take all of their savings out of a DC plan within three to five years after retirement.
Many DC plan sponsors are now waking up to the fact that what happens
DC plan sponsors are waking up to the fact that what happens after retirement is just as important as what happens before
after retirement is just as important as what happens before. To help retirees generate adequate income over their lifetimes, some plan sponsors are considering managed accounts or in-plan annuities. But these could bring unneeded complexity and oftentimes mixed results. A more efficient and effective way for DC plans to go about this is by ensuring their existing target date fund series contains a retirement income fund with the "actual" goal being to maximize income throughout a participant's retirement. This may sound logical, but many retirement income funds within a target date series don't expressly pay a targeted yield, instead they are simply a continuation of the glidepath.
Well-designed retirement income
A well designed retirement income fund can be an effective risk mitigation tool. Right off the bat, it eliminates transition risk and portability risk, which occur when plan participants are unsure what to do with their savings once retirement date rolls around. Then there's market risk, which innovative retirement income funds seek to mitigate via a dynamic glidepath. 'Dynamic' investing is essentially
DC plans need to ensure that their existing target date fund series also includes a retirement income fund
the ability to up-risk or de-risk the portfolio by strategically shifting the glidepath according to changing market conditions. The end result is to generate a relatively high and consistent stream of income while participating more fully in rising markets, and preserving capital to a greater degree in volatile ones.
This kind of dynamic approach, with its built-in flexibility and responsiveness to changing market environments, is designed to better prepare employees for the uncertainty of retirement. By actively shifting the glidepath to get the best out of an appropriate mix of stocks, bonds and cash, dynamic investing positions an employee for better outcomes throughout retirement.