increasingly dependent on defined contribution plans to reach their retirement income goals. In the United States, fewer than one in five workers have access to a traditional defined benefit pension program. To retire financially secure, workers need well-designed defined contribution (DC) plans – as most will rely on such plans for at least a third of retirement income. Those who have access to a well-designed plan and are contributing at a sufficient level are likely to succeed. Unfortunately, not all workers are offered a DC plan.. and plans that are offered may have a less-than-optimal design.
As of 2015, we estimate that only about half of U.S. workers have access to a DC plan; in particular, people working part-time or for small employers often lack plan access. Some countries such as the United Kingdom and Australia have addressed DC plan availability by mandating that employers must offer and enroll employees into such programs. At this writing, we anticipate retirement plan availability will increase in the United States as multiple states and possibly the federal government will roll out compulsory programs or regulatory change to ease the burden of offering plans.
As plans become increasingly available, our hope is they offer an investment structure that places participants on a path to success.
This book is designed to assist plan sponsors and providers to structure investment menus that help participants meet their retirement goals. Our earlier book, Designing Successful Target-Date Strategies for Defined Contribution Plans: Putting Participants on the Optimal Glide Path (2010), provided a framework for understanding the growing role DC plans have come to play for Americans planning for and transitioning into and through retirement. In that volume, we reviewed the origins of DC plans with a focus on building custom target-date strategies, an innovation that is now widely adopted, particularly within the largest U.S. plans. Our earlier book was a resource that helped plan sponsors and their consultants as they considered how to create their own custom target retirement-date strategies. It was written at a time when DC plans were experiencing significant growth in both prevalence and assets.
In the intervening years, the trends we identified have accelerated. Global DC assets in seven major markets (representing more than 90 percent of total assets) swelled to $15.6 trillion in 2015, a 7.1 percent 10-year annual growth rate that was more than double the 3.4 percent pace for defined benefit plan (DB) assets, according to Willis Towers Watson. At the end of 2015, DC assets in these markets represented 48.4 percent of combined DC/DB assets, up from 39.9 percent in 2005. With continued adoption of DC plans and higher contribution rates – fueled increasingly by automatic enrollment – DC assets will eclipse those of DB plans in the near future.
As contribution rates climb, DC assets will increasingly flow into investment defaults. In the United States, more than 80 percent of plans use a qualified default investment alternative (QDIA, an investment vehicle used for retirement plan contributions in the absence of direction from the plan participant); target-date funds dominate, being offered by about 75 percent of plans. According to PIMCO’s ninth annual Defined Contribution Consulting Support and Trends Survey (published in 2016 with data collected in 2015), 96 percent of consultants supported target-date funds as the QDIA.
As a result of the increasing popularity and importance of DC plans, plan sponsors, consultants, advisors, investment managers, attorneys, academics, and other professionals are keenly interested in DC plan design. But as they seek information and guidance, they often find only piecemeal information on how to thoughtfully structure a DC plan. They are left not knowing where and how to begin. To help answer the questions of those interested in and responsible for DC plans, this book offers a framework, information, analytics, and ultimately a guide to building successful DC plans.
Throughout these pages, we focus the discussion first and foremost on meeting the DC plan’s objective – which for nearly all plans today is to provide participants with sustainable retirement income. This retirement income objective may differ from the past when many plans may have been considered supplemental savings programs. Those days are over and new approaches are required. By identifying and focusing first on the plan objective, plans can be managed to meet that objective, both during asset accumulation and retirement-income drawdown.
We believe this outcome-oriented approach presents the best path to success. Our interest in focusing on outcomes extends from our collective experience over the past decade. We have learned that the old approaches to DC plan design are often misaligned to a plan’s objective and can present participants with untenable risk. By aligning investment design to the plan objective and managing both to maximize return and minimize risk, workers are likely to succeed; and what’s more, plan sponsors are able to meet their fiduciary duty to participants.
At PIMCO, we understand that meeting the objective of outcome-oriented investing may be easier said than done. To help plan fiduciaries grapple with this challenge, we have developed proprietary analytics and other resources to help inform and guide DC investment development. Our commitment to contribute to the effective design and success of DC plans for sponsors and participants alike is what motivates us to return to the printing press with a new book for 2017.
HOW THIS BOOK IS ORGANIZED – AND HOW TO USE IT
The book is divided into three parts. Part One (Chapters 1–4) provides the background that readers will need to build their understanding of DC plan design rudiments. Part Two (Chapters 5–9) sets out a guide to understand the overall DC investment structure and menu of choices plan sponsors and participants face. In Part Three (Chapters 10 and 11), we return to a focus on the individual, both in the U.S. and other markets around the world. In it we explore the specific plan features and investment choices retirees seek as they consider whether to stay in their plans, and how a DC plan balance could be turned into a lifetime of retirement income.
Here’s what’s happening, chapter by chapter:
Chapter 1: We start with an overview of the new reality. For most workers success is up to the individual, as DC plans have replaced traditional pension plans as the primary source of employer-provided retirement income. While the objective is often the same, design around the globe varies significantly so we look at the types of plans by major market. Then we discuss what this shift means as fiduciaries design DC plans: What are a fiduciary’s responsibilities? How can consultants and advisors help? How can plans be designed to succeed? Where does a plan sponsor begin? This chapter includes an assessment of the extent to which workers globally may rely on DC plans for retirement income, showing how the audience for DC plans continues to expand. We discuss the challenges that plan sponsors face in governing plans and share views on the importance of both contribution and investment design. We also consider automatic enrollment and contribution escalation, and then turn our attention to investment design.
Chapter 2: In this chapter, we introduce a framework for evaluating and structuring DC plans. We discuss how to align investment design to the plan objective and introduce the innovative PIMCO Retirement Income Cost Estimate (the “PRICE” approach) as a methodology to quantify both the historical and prospective cost of buying a lifetime income stream. The PRICE approach helps fiduciaries to identify the number, or amount of savings, a worker needs to retire. In this chapter, readers will be able to ask – and answer – the questions: What is the PRICE of retirement? Is your company’s DC plan on track? We also reach into the world of behavioral finance to help understand why numeric or quantitative frameworks can provide an important counterpoint to the biases that may otherwise shape our behavior.
Chapter 3: Here we turn to plan investment structure, including an investigation of the number of tiers and investment structures available in plan design. We consider qualified default investment alternatives (QDIAs), including the types of investments and prevalence of each. Then we look at the core investment lineup, helping readers understand how to think about the number and type of investment offerings. We also consider active versus passive investment choices, and brokerage windows (whether full or mutual-fund-only). Finally, we consider the investment structure, whether mutual fund, collective
