DC Plans Important to Retirement Security

Defined contribution (DC) plans are a critical part of the U.S. retirement system, says a research report.

“Building Retirement Security Through Defined Contribution Plans,” authored by Professors Jeffrey R. Brown and Scott J. Weisbenner from the University of Illinois at Urbana at Champaign, was written in cooperation with the American Council of Life Insurers. The report indicates that positive strides have been taken by DC plan sponsors in recent years, especially in the areas of increasing participation, providing more diversified portfolios and providing immediate eligibility to employees that are more likely to switch employers at various times throughout their career.

As the DC system has grown, say the authors of the report, it has evolved to better meet the needs of employers and participants. “Median employer plus employee contribution rates are now approximately 10% of income,” they say. “Additionally, the widespread use of life cycle and target-date funds as default investment options, as well as the decline in allocations to employer stock, has greatly improved the asset allocation of typical participants. As a result of these and other improvements, today’s defined contribution system is preparing millions of participants for a secure retirement.”

The report addresses critics of the DC system who claim that defined benefit (DB) plans are a better retirement vehicle. “The good old days of the DB plan were not actually so good,” say the report’s authors, pointing out that prior to the protections offered by the Employee Retirement Income Security Act (ERISA), employee retirement benefits were “exposed to substantial funding risk and short-tenure workers often received no benefits at all.”

In addition, the report finds as a result of ERISA protections, many employers have found that providing a DB plan no longer passes “the cost-benefit test in light of a changing economic environment.”

As for improvements to the DC system, the authors recommend, “Policymakers and the employer community should work together to continue to build on the substantial progress already made regarding coverage, participation and contributions, as well as in the promotion of guaranteed retirement income and other retirement risk management practices.”

Other recommendations include improving incentives for employers to offer plans and making part-time and recently hired workers eligible to participate, as well as increasing employee contribution rates through automatic enrollment and automatic escalation plan features.

In terms of changes on a broader level, the report suggests that the aim of DC plans be refocused from simply accumulating wealth to “treating DC plans as a path to guaranteed retirement income.”

The full text of the report can be downloaded here.