In a new report, “Design Matters,” the Defined Contribution Institutional Investment Association (DCIIA) analyzes what is working in defined contribution (DC) plans and if additional legislation could strengthen them further. DCIIA concludes that plans have the tools they need to get workers prepared for retirement—they just need to use them more vigorously.
The Pension Protection Act (PPA) of 2006 was a watershed moment for DC plans, and has helped change them dramatically, DCIIA says. Before PPA, 19% of DC plans had automatic enrollment, and today that is 60%. Previously, 9% of plans had automatic escalation, and today that is 80%. Stable value and money market funds were the most common qualified default investment alternative (QDIA), and today 85.5% of plans use target-date funds for the QDIA.
“The difference between retirement savings for workers in plans with automatic features and those whose plans do not have auto features is dramatic,” DCIIA says. “The DC system is already equipped with many of the tools it needs to drive improved retirement outcomes. Wider and more consistent adoption of these tools, including automatic features and adequate initial savings rates, could make a significant difference for today’s workers.”
DCIIA estimates that in plans without automatic features, a person retiring at age 66 would have five times their final salary in savings, whereas a person in a plan with automatic features would retire with 6.66 times their final salary in savings—more than a 30% difference.
DCIIA says that the median initial deferral rate for DC plans is an inadequate 3% and that there is a need for more “robust defaults.” The organization says that existing legislation is sufficient to support higher deferral rates and escalation up to 15%. DCIIA estimates that when plans use an initial deferral rate of 6% and automatic escalation up to a 10% cap, participants could retire with 7.9 times final salary. If it is increased up to a 15% cap, participants could retire with eight times their final salary.
DCIIA also says it is very important for plans to limit loans, hardship withdrawals and cash-outs, as this could increase participants’ holdings by as much as 10%. Today, 86.6% of plans permit participants to take out a loan against their DC plan, with 45.6% of plans allowing more than one loan at a time—and many participants default on the loans upon job termination. Nearly 90%, 87.4%, of plans also allow hardship withdrawals. DCIIA estimates that when a plan optimizes auto enrollment with no leakage, a participant could retire with 8.54 times their final salary.
DCIIA recommends that plans set up a payroll deduction program to help workers set up emergency savings and that they work with their service providers to make it easier for workers to roll their money out of and into their plans. DCIIA also believes it would be useful for service providers to educate participants about the damages DC loans can have on their retirement savings, that they reduce the number of permissible loans to one and that they permit outstanding loans to be repaid even after job termination.
Furthermore, DCIIA supports financial wellness programs that encompass non-retirement issues, as they can help reduce stress at work and increase productivity. DCIIA concludes by saying it hopes that the argument it makes for more robust use of auto features and financial wellness programs will motivate retirement plan advisers and sponsors to embrace them.
DCIIA’s full report, “Design Matters: The
Influence of DC Plan Design on Retirement Outcomes,” can be downloaded here.