In Part II and III of this series, we focused on how decumulation strategies can increase DC plan value. In this Part IV, our final instalment in this series, we will focus on other methods through which DC plan value can be increased.
Any strategy aimed at maximizing DC plan value should be sensitive to the particular needs and circumstances of plan stakeholders. For example, where, as is most often the case, the majority of an employer's workforce are not sophisticated investors, pooled, administrator managed DC investments may be seen as a considerable value-add, increasing DC benefit security. By contrast, this strategy may be viewed as overly "paternalistic" to participants in an institutional investors' DC plan. More on this particular strategy below.
Pooled DC Investments
The majority of DC plan designs require members to direct their own investments. However, this is not a mandatory or inherent feature of DC plans. In recent years, we've witnessed interest from certain plan sponsors in evolving their DC plan designs from member directed investments towards the use of professionally selected pooled investments. From an employee's perspective, there are a number of potential advantages with this approach – lower investment fees, pooling investment risk and (for most participants) a more systematic asset allocation, diversification and rebalancing strategy.
Plan sponsors and administrators may be concerned about the fiduciary risk associated with this option given that a member's retirement income will be directly based upon investment decisions made by the plan administrator and its delegates. However, any such concern should be weighed against the fact that a plan administrator is held to a standard of prudence (e.g., have they prudently selected investment managers and related fee arrangements; have they prudently supervised the performance of investment managers and the investment options made available etc.), which is not measured based solely on investment performance, but rather on the reasonableness of the investment process in place as part of overall plan governance. These fiduciary obligations also apply regardless of whether investments are pooled or member directed. Some may even argue that there is the potential for greater legal exposure where investments are member directed since members are being asked to make complicated financial decisions that they may not have the requisite expertise to make.
Target Date Funds
Target Date Funds (TDFs) are another approach to DC investments that (for the most part) take investment decisions out of the hands of plan participants. A TDF is a type of mutual fund where the asset allocation mix will change as the DC member comes closer to the "target date" (i.e., retirement). Generally speaking, the asset allocation in a TDF will favour investments that typically provide higher returns (such as equities) in early years and become more conservative (i.e., more heavily weighted in fixed income investments such as bonds) as the "target date" approaches, in order to preserve capital. As TDF products typically permit the investor to set their own "glide path", based upon their level of risk tolerance, there would be a degree of investment discretion left to DC plan participants.
While TDFs are built upon certain principles, individual products can vary quite considerably, reinforcing that any plan administrator (or their delegates) selecting TDFs will need to carefully consider which product best suits the needs of plan participants and continue to monitor the product on an ongoing basis.
Employees may not be maximizing value from their employers' DC plan for the basest of reasons – they have not elected to participate, or have chosen not to participate until closer to retirement.
There is growing evidence that "auto-enrolment" (where members have to opt-out, rather than opt-in to participate) increases plan participation levels. For example, in an article in Benefits Canada, Sonya Felix pointed to a U.S. study by Fidelity Investments in 2011 that showed that average participation rates in 401(k) plans with auto-enrolment were 82%, compared to 55% in plans without. (U.S. 401(k) plans, generally speaking, being the rough equivalent to Canadian DC plans.)
When considering whether auto-enrolment is a good fit for your organization, a great starting point is the list of questions, below, which were raised in Louise Pellerin-Lacasse's Benefits Canada article on auto-enrollment.
- How does automating employee decisions fit with your culture?
- What is the impact on your budget for compensation and benefits?
- Do you plan to address financial literacy?
- What is the impact on your payroll system?
- What will your default investment option be?
We encourage you to read this article for Louise's helpful discussion on each of these questions.
This four part blog series has only scratched the surface of decumulation and other strategies to maximize DC plan value and by no means is intended to reflect an exhaustive discussion. For any plan sponsor evaluating its existing plan design, changes made will need to be tailor-made to the needs of the organization and its DC plan participants. We have sought to highlight that a number of tools may be available to plan sponsors to maximize their existing DC plan value without materially increasing administration costs or fiduciary liability. Addressing any existing undervaluation may provide plan sponsors with a more attractive DC plan for workforce recruiting and retention in addition to helping employees on the path to meeting their retirement goals and needs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.