From Savings to Security: The Future of Innovation in DC Plan Design

By Angela M. Antonelli

The Georgetown University Center for Retirement Initiatives (CRI) convened an invitation-only one-day policy forum in June 2018 with approximately 100 senior industry leaders, policymakers, and stakeholders to examine some of the key challenges in designing a retirement savings system focused on improving long-term outcomes to strengthen retirement security for millions of Americans.

The key takeaway from the meeting was that any real improvement in retirement security and financial well-being would require expanding the discussion beyond just a consideration of retirement savings. If retirement plans shift from simply managing account balances to helping individuals think about not only when they plan to retire but also how much income they will need in retirement, it will help direct smarter savings and investment decisions. A paradigm shift must occur, moving away from a myopic focus on wealth accumulation to the more-important long-term goal of generating and protecting lifetime income.

The Retirement Security Challenge

In the United States, workers are being asked to take responsibility for their financial well-being in retirement now more than ever. What used to be considered the foundation for building a secure retirement — Social Security, employer-provided pensions, and personal savings — has been weakening for decades as traditional defined benefit (DB) pension plans have been replaced by a defined contribution (DC) system of savings which was meant to supplement and not replace traditional pensions. Most employers today offer DC plans to their workers as the primary, and often sole, retirement program.

Making this shift worse is the reality that more than one-half of all private sector workers — approximately 55 million Americans — do not even have access to retirement savings programs through their employers to help them save.

The deterioration of retirement security is one of the greatest economic and financial challenges facing our nation today. Between now and 2030, 10,000 baby boomers will retire every day. Those age 65 and over in 2030 are projected to be more than 74 million, representing more than 20 percent of the total population. Approximately 60 percent of working age individuals do not own any retirement account assets, either from an employer-sponsored 401(k) type of plan or an IRA, nor do they have DB pensions. One estimate of the median account balance is approximately $40,000 for those with retirement accounts, meaning that even those who are trying to save for retirement will not have enough.

With today’s DC plans, the responsibility for making the complex savings and investment decisions that will have a significant impact on the amount of money they will have available for retirement has shifted to workers themselves. Because most workers often do not have the access, information, or knowledge to make these decisions, it is important for DC industry leaders and policymakers to consider the ways in which DC plan structures can improve and evolve to increase participants’ chances for success.

Demographic Trends Shaping the Retirement Landscape

Significant demographic changes, including an increasingly older and more-diverse population, will require leaders to rethink policy and investment strategies that will facilitate innovation, improve productivity, strengthen the economy, and improve overall financial well-being.

As the population ages, the millennial cohort represents the key to achieving future economic potential, but they currently face daunting financial hurdles that include lower labor force participation rates, lower earnings, less access to standard employment benefits, and a much-higher rate of debt.

A key focus for the future has to be helping millennials achieve their full potential with innovative public and private sector solutions to address retirement, healthcare, and other needs that also keep pace with approaches that enable more flexible work structures.

Other demographic trends, including a shift away from homeownership, the rise of the “gig economy,” and urbanization, amplify the need for policymakers and industry leaders to come up with new and creative solutions.

Technology Provides Promise for Planning and Saving

Technology has played a role in disrupting the retirement landscape by changing the nature of work, but now it also can be deployed in a variety of ways to encourage people to save and to improve outcomes. Innovations in automation and data are reshaping how many Americans save for retirement. Auto-enrollment, automatic deductions, and target date funds now represent common components of 401(k) retirement savings plans.

Technology today helps to streamline efficiency, delivering more attractive, cost-effective solutions. While innovative technology alone will not solve the problem, it can play a vital role in the effort to improve returns, maximize results, and create post-retirement income plans that will ensure retirees are prepared for life after work.

Technology can play an important role in helping retirees, or those planning for retirement, to use simple techniques to build financial confidence. Whether it’s an app that nudges a person to save, algorithms that can customize an individual’s retirement savings strategy better, or videos that explain retirement savings concepts in short, digestible formats, technology is part of the solution. In addition, the ability to leverage machine learning and artificial intelligence can help plan sponsors automate and individualize retirement planning and facilitate decisionmaking to improve long-term outcomes.

At the same time, consumer privacy concerns must be considered carefully to maximize the benefit of technology and data, and improve engagement rates. These concerns transcend the retirement savings community, and must be incorporated into successful solutions.

State-Facilitated Programs Expand Access and Create Opportunities for Collaboration

Individual states have begun enacting innovative programs for private sector workers who do not have access to employer-sponsored savings plans. To date, 10 states and one city have adopted new programs reflecting a range of approaches, including individual retirement accounts (IRAs), multiple employer plans (MEPs), and marketplaces. Small businesses and the self-employed benefit from these programs because they are much less likely to offer or have access to retirement savings plans.

Although states can certainly establish their own programs, they also should explore whether collaboration across state lines would be a better way to serve their citizens. Both the Section 529 college savings accounts and ABLE savings programs provide models for how states could develop multi-state retirement savings programs. Collaboration through multi-state alliances provides the opportunity to come together to achieve larger-scale solutions that can be more cost-effective by sharing administrative costs and reaching more workers.

Defined Contribution Plans Can Learn from Defined Benefit Plans

A DC plan essentially operates as a DB plan for one person with all of the risks, costs, and responsibilities for investment performance and the decumulation of assets left to the individual saver to manage. To solve this problem, DC plans can seek to emulate the best aspects of DB plans. One of the most-successful features of DB plans that DC plans have begun to adopt is taking advantage of tools such as auto-enrollment and auto-escalation features that help workers begin to save meaningful amounts in DC plans.

Another way DC plans can learn from DB plans is by paying attention to simplicity of investment selections. With DB plans, the savings are pooled and invested together, aggregating risk and expense. By limiting choices and offering a default investment option, such as one set of target date funds, a DC plan provider can keep costs lower than one that tries to manage many different types of funds.

Another important consideration is whether the investment return of DC plans can be improved to deliver more income for the same contributions. If one dollar invested in a DB plan generates significantly more income than a dollar invested in a DC plan, that would suggest a need to explore whether greater asset diversification, including private equity, private real estate, or hedge funds, could boost retirement income for the same level of contributions.

Finally, DC plans would do well to take a page from DB plans by communicating about retirement income, not just providing abstract savings information. Turning the conversation to planning for income during retirement requires individuals to look beyond the accumulation phase and will help them to understand the concepts better that drive their savings and income requirements in retirement.

Retirement Income Must Last a Lifetime

All this innovation has one clear goal: to ensure that retirees will be able to replace an adequate amount of their pre-retirement income in retirement. During the accumulation phase of retirement planning, default options such as auto-enrollment and auto-escalation are now providing a way to improve savings to help meet lifetime income needs. However, more can and should be done to educate individuals about how their pot of savings would translate into monthly income and whether this income does, indeed, meet their needs in retirement.

The transition from an accumulation mindset to drawing an income to be used in retirement presents its own set of challenges. Individuals need to be aware of the options available to them and understand that decisions regarding how they choose to allocate their retirement income — along with external factors such as interest rates and inflation — can affect their monthly income in retirement.

Annuities can provide an appealing option for some retirees. The prospect for greater adoption of annuities in the future will depend on the ability to design them in a way that recognizes behavioral realities and offers investors flexibility to meet their unique circumstances — but much more has to be done to provide information and education, and to improve transparency about the different types of products available today and the value of creating a stream of lifetime income.

While the interest in lifetime income solutions grows, much more can and should be done in the design of DC retirement savings plans. DC plan sponsors remain concerned about the litigation risks associated with including some type of annuity or guaranteed income option in their plans. Nevertheless, as more plan participants are asking about information and options to help them manage their portfolios, an increasing number of large plan sponsors is beginning to explore income options. Employers and plan sponsors should be able to design lifetime income solutions and strategies that work well for their employees, and policymakers can help address such concerns.

The Goal is Stronger Security Through Better Outcomes

If strengthening retirement security is the goal, then success can only be measured based on improving long-term outcomes. Unfortunately, as DC savings plans have taken the place of traditional DB plans, the shift has been away from outcomes to inputs. Returning to a true focus on outcomes requires moving away from a myopic focus on savings to evaluating whether retirees will have sufficient income to meet their needs once they stop working.

This approach to retirement security considers an individual’s retirement life cycle. This includes the key phases of access, participation, accumulation, and decumulation. Better and more-effective deployment of technology, data, and education can contribute to the development of new ways to improve each phase of the life cycle.

Industry leaders, policymakers, and other stakeholders working together can and must rise to meet the challenges and shortcomings of today’s retirement system and implement innovative new solutions that measurably improve long-term outcomes focused on improving the financial stability and quality of life for retirees.

Angela M. Antonelli is a Research Professor and Executive Director of the Georgetown University Center for Retirement Initiatives (CRI).

March 2019, 19-02