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Lucas Sees “Defined Benefitization” of Defined Contribution Plans

Everyone knows the bad news about 401(k) plans. Unlike a traditional pension plan, they don’t provide any guaranteed level of income for retirees. Too many workers don’t participate in them, and when they do, too few invest wisely—or at an adequate level. Yet 401(k)s and similar defined contribution plans can provide workers with a satisfactory level of retirement income if employers build the right features into them, says plan expert Lori Lucas. Increasingly, they do.

“This is one of the most interesting times in the evolution of the retirement plans,” Lucas told attendees at the SVIA’s annual forum in Washington, D.C., in October. “Employers are becoming quite a bit more paternalistic with respect to defined contribution plans. They’re not looking to shift responsibilities to employees; in fact, they’re looking to take back certain types of responsibilities. They want to help participants in defined contribution plans much the same way they once helped them with defined benefit plans. I call this trend the defined benefitization of the defined contribution plan.”

Lucas is senior vice president and defined contribution practice leader for Callan Associates, an investment consulting firm serving fund sponsors, investment managers, financial intermediaries, and mutual fund boards. One of the key trends making defined contribution plans more like defined benefit plans, she said, is the increased use of automatic enrollment—something that should get a boost from the recently passed Pension Protection Act (PPA), which provides some explicit fiduciary safe harbors for plan sponsors who adopt it within the Act’s prescribed guidelines.

The PPA also endorses the concept of automatically increasing participant contributions, again within specified guidelines, which also should be good for plan participants. Lucas cited a recent survey by the consulting and recordkeeping firm Hewitt Associates indicating that 17 percent of plan sponsors already offer automatic deferral increases and 13 percent plan to add that feature.

Other promising trends that should make defined contribution plans more valuable to plan participants, Lucas said, include:

• offering participants greater access to premixed asset allocation funds, such as target-date lifecycle funds;
  
  
• defaulting participants who don’t make investment choices into balanced or premixed funds rather than more conservative funds;
  
  
• providing participants with greater access to best-in-class investment managers rather than limiting them to a single fund company’s products; and
  
  
• blending alternative asset classes into target-date funds.

Despite those positives, Lucas said plan sponsors may need to continue pushing hard in some areas to make defined contribution plans as effective as possible. For example, the PPA says employers can’t automatically default more than 10 percent of a participant’s salary into their retirement savings account without their consent. Capping contributions at that level isn’t a great idea, Lucas says, because many workers may need to contribute at a higher rate to ensure a financially secure retirement—especially if they don’t start saving early in their careers. Also, employers will have to be careful to ensure that by establishing default deferral rates lower than 10 percent—the Pension Protection Act only requires a minimum rate of 3 percent in the first year of participation—they don’t unwittingly encourage some workers already contributing at higher levels to drop down to the lower “endorsed” rate.

Looking ahead, Lucas predicted that one of the next major trends in the defined contribution plan marketplace could be the introduction of guaranteed income products, along the lines of an annuity, for plan participants who have reached retirement age and want to assure themselves that they won’t outlive their savings. “I don’t think we have the perfect product for that out there, or that it’s even that high on the radar screen of employers,” Lucas said. “But I do think we’ll see more of it in the years ahead, and it does kind of close the loop on the defined benefitization of the defined contribution plan.”

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