While it has always been understood that members bear the investment risk in defined contribution (DC) plans, nothing could have exposed these inherent risks better than the implosion of the equity markets in 2008.
The Watson Wyatt DC Index shows that the average DC member invested in a balanced fund with 50% equity exposure would have lost about 30% of his or her DC account’s income purchasing power from December 2007 to December 2008. This means, for a plan member to have the same level of retirement income on Dec. 31, 2008 that he or she would have had on Dec. 31, 2007, retirement would have had to be postponed six years, from age 60 to 66. As of Sept. 30, 2009, retirement at 64 will provide the same level of income as retirement at 60 would have on Dec. 31, 2007.
Sadly, there are limited options for DC members. They can postpone retirement, accept a more modest retirement lifestyle or increase savings inside and outside of their DC plans.
But DC plans were never designed to achieve a target replacement ratio the way defined benefit (DB) plans are. In fact, to replicate income replacement ratios found in a typical DB plan, the average total employer and employee contribution rate to a typical DC plan should be close to 14% to 18%.
While 83% of plan sponsors in Watson Wyatt’s most recent DC survey are concerned that their employees will have insufficient retirement savings, it is unrealistic for all DC plan sponsors—or members—to provide contributions at the levels required.
But there is good news. Unlike in the U.S., employer contribution rates are not decreasing in Canada. DC plan sponsors want to help their members achieve a reasonable retirement income. In fact, 75% of survey respondents are making or have made changes to their plans to help members maximize returns—changes such as replacing a money market default fund with a balanced or target date fund, revising the plan’s investment structure and increasing investment education.
Plan sponsors can also look to other cost-neutral strategies:
• Increased and targeted communications can lead to higher member participation, better decision-making and greater appreciation of the plan as part of the overall compensation package.
• Reviewing a company’s plan governance can uncover inefficiencies in plan administration, freeing up resources for other purposes.
• An administration audit can uncover costly administrative practices.
• A plan design review can uncover practices with unintentional costs (e.g., payroll taxes).
• In some cases, revising the split between the employer’s required and matching contributions can provide the same overall employer contribution while encouraging greater member participation.
• Undertaking regular fee benchmarking can lead to a significant reduction in overall fees.
Should plan sponsors uncover any significant savings, they can be redirected to the plan as increased employer contributions. This will have a neutral impact on overall employer costs while providing a benefit improvement to members.
Plan sponsors can help their DC members achieve better outcomes in retirement, even if they cannot increase contributions. By pulling on the other levers that will increase members’ savings—incentives for higher levels of employee contributions, cost-effective benefits delivery and improved investment structures—plan sponsors can help manage some of the DC investment risk incurred by their plan members.
Lori Satov is a senior consultant in Watson Wyatt Canada’s retirement practice in Vancouver, and Dan Morrison is a senior consultant in Watson Wyatt Canada’s retirement and investment practices in Calgary.
lori.satov@watsonwyatt.com
dan.morrison@watsonwyatt.com
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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the November 2009 edition of BENEFITS CANADA magazine.