This is the fifth and final article in a series that has revisited the design of hybrid pension plans—plans that deliver the better of a defined benefit (DB) promise and a defined contribution (DC) account balance. I will wrap up this series by addressing the issue of employee communications, which in my mind includes the provision of appropriate investment options.
While not specifically relevant to this issue, the plan design that this series has addressed is the following:
• DC component: 5% of earnings contributed by both the employer and the employee for a total contribution of 10%
• DB component: 0.8% of final three-year average earnings for each year of employment, with no inflation protection
This design is intended primarily to deliver a DC benefit. The DB component acts solely as a “safety net.” Only in the event of severe adverse economic conditions would the DB component affect the benefit being delivered from the plan. From the perspective of communications to employee participants, this plan should be treated like a pure DC plan, with a communications strategy that addresses the design of the investment options, equips employees to make appropriate investment decisions and supports employees in the establishment of their retirement savings strategy.
The design of the investment options should be considered as part of the communications strategy. Different messages can be delivered depending on whether employees are given a broad or a limited range of options. There are also legal considerations in this aspect of design that are beyond both the scope of this article and my expertise.
The appropriate communication of DC plans is set out in the CAP Guidelines. These guidelines have been covered in many articles, and I do not intend to address them in detail here. Rather, I am going to pose a potentially controversial question: should the prime responsibility for communicating DC plans, including providing investment education, rest with the sponsoring employer?
Consider what obligation exists when an employer deposits their employees’ periodic pay into their bank accounts. There is no obligation on their part to provide education to ensure that their employees do not overspend their pay or make inadequate personal provision for future expenses such as children’s education expenses or retirement income. There is a general assumption that individuals are sufficiently well educated to be able to make these decisions for themselves.
Why can we not follow the same approach for DC plans? In my mind, the foundational reason is that most people do not have the basic education to make informed decisions for their DC investments. This is a failing that can be traced back to high school. Basic life skills—balancing a bank account, establishing a budget, the simplest forms of financial planning—should start to be taught in high school. The lack of these basic building blocks of knowledge is the reason that DC sponsors encounter difficulty in communicating their plans.
In a world where most people will depend on DC arrangements for their retirement income, we as a society need to ensure that they are equipped to make knowledgeable choices. That education should start in high school. We will also need to have follow-up classes available, perhaps through employers, but more likely through the more routine avenues of continuing education.
While it may take a while for this structure to be effective, when it is, the employer’s role in communicating their DC plans should be no more than a supplementary one, rather than the primary role that it is today. Shareholders (including most pension plans) make capital available to companies because they believe that these companies’ missions will generate a return on that capital. These missions could be making widgets or providing services, they do not include educating employees. While no one will deny that employers have some obligation to explain their human resource programs to their employees, they should not be expected to provide basic education on these matters any more than they should be expected to educate employees about the basics of the three Rs.
To date, employers have attempted to fill the educational vacuum that currently exists. Because of there will be a long transition to a new educational system, employers will need to continue in this role for the foreseeable future. But, the time is now to start putting the primary responsibility in a more appropriate place, the education system.
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