OECD Issues Recommendations for the “Good” Design of Defined Contribution Retirement Plans
By Pablo Antolin
Because defined contribution (DC) retirement plans have increasingly become an integral, if not the main, part of most countries’ overall pension systems, the Organization for Economic Co-operation and Development (OECD) recently issued several recommendations for the implementation and management of these plans. The recommendations are intended to build trust in the design of DC plans by ensuring that the best interest of plan participants is considered, as well as to improve the robustness of retirement systems.
The OECD decided to review its 2012 “Roadmap for the Good Design of DC Pension Plans” to incorporate new developments, research, and best practices in retirement plan design. After developing a set of draft recommendations with pension and insurance regulators and supervisors from OECD countries, the draft was made available for public comment and consultation. The OECD Council approved the final draft in February 2022.
This report incorporates the OECD Working Party on Private Pensions’ Roadmap, first developed in 2012 and updated in 2021, which has become the main instrument for retirement plan design around the world. Its recommendations are intended to assist countries in designing both occupational and personal DC retirement plans. More specifically, the recommendations are crafted to ensure that the three underpinnings of such plans — contributions paid, investment returns, and the way assets are paid out over retirement — are designed to achieve the objective of retirement income adequacy more effectively, while being flexible enough to address the differences between countries and systems. To this end, the “good” design of DC plans should take into consideration these 10 recommendations:
- Design DC plans that are consistent with their long-term purpose and role in the retirement system. The design should promote resilience against shocks and be stable enough to provide certainty and instill confidence over the long term. It should also be consistent with the other components of the retirement system and its objectives, and coherent among the accumulation and pay-out phases. Policymakers should assess current and potential retirement incomes regularly, considering broader economic and demographic factors and risks to determine whether DC plans are able to fulfill their role in meeting adequacy objectives.
- Make DC systems as inclusive as possible. Where mandatory enrollment is not considered opportune, automatic enrollment — covering all employees and possibly the self-employed — can enhance participation while giving individuals the possibility to opt out. Financial incentives are also useful tools to promote saving for retirement. Using default options and offering a limited number of options for the contribution rate, the investment strategy, and the pay-out can simplify decisions when members need to make them and encourage participation. Policymakers should avoid eligibility criteria that may disadvantage specific groups, such as women and people in non-standard forms of work. They should also take care when considering design features that may make saving for retirement attractive (e.g., guarantees and early access to funds), but could end up reducing retirement income. Any early access to retirement savings should be a measure of last resort and based on individuals’ specific hardship circumstances.
- Ensure total contributions are high enough to achieve retirement income objectives. Automatic and gradual increases to contribution rates can help members reach appropriate contribution levels over their careers. Flexibility regarding the level and timing of voluntary contributions could allow individuals to save based on their capacity, leading to higher overall contributions. Employer matching contributions can also promote employee contributions, while technology can help members contribute more by simplifying the contribution process and providing access to affordable financial planning. Encouraging members to contribute for longer by starting early and postponing retirement improves their chances of reaching their desired retirement incomes, particularly when life expectancy increases.
- Design financial incentives to maximize the impact on enrollment and contributions. Tax rules should at least not discourage individuals to save for retirement. They should be straightforward, stable, and common across retirement saving plans to avoid confusion. The design of financial incentives should reflect the retirement saving needs and capabilities of different population subgroups. Middle- to high-income earners tend to respond to favorable tax treatment, while low-income earners may be more likely to respond to matching contributions and fixed nominal subsidies. The incentives should be updated regularly to maintain the attractiveness of saving for retirement.
- Promote low-cost and cost-efficient retirement arrangements in both the accumulation and pay-out phases. It is essential to promote initiatives to foster competition and improve disclosure, comparability, and transparency. They may need to be complemented with appropriately designed pricing regulations and structural solutions that protect members’ interests. Structural solutions should have strong institutional and governance frameworks, and can include tender mechanisms, allocation of individuals to quality low-cost providers, cost-efficient consolidations, large industry-wide nonprofit providers, and independent centralized providers. Measures to promote cost efficiency should balance the benefits of fair competition and economies of scale with the risks of an oligopolistic outcome (only a few sellers, and each seller has a high percentage of the market). Finally, fees charged to participants should be aligned with the costs that providers incur and the value provided to participants.
- Ensure that all individuals have access to appropriate and sustainable investment strategies and a well-designed default, where applicable. For people unwilling or unable to choose, a default investment strategy should be established in line with the objectives of the DC retirement system and the structure of the pay-out phase. For example, life cycle investment strategies can be designed to encourage members to take on some investment risk when young, and to mitigate the impact of extreme negative outcomes when close to retirement. For people willing to choose their investment strategy, different investment horizons and risk profiles should be offered. To assess and monitor the appropriateness of different investment strategies against a policy objective, labor; financial; economic; demographic; environmental, social, and governance (ESG); and other long-term sustainability risks affecting DC pensions should be considered.
- Ensure protection against longevity risk in retirement. DC plans should provide some level of lifetime income as a default for the pay-out phase unless other arrangements already provide for sufficient lifetime income payments. Lifetime income can be provided by annuities with guaranteed payments or by non-guaranteed arrangements where longevity risk is pooled among participants. The choice of the type of arrangement will depend on the desired balance between the cost of guarantees and the stability of retirement income. Flexibility could be provided by allowing for partial, deferred, or delayed lifetime income combined with programmed withdrawals. Full lump sums should be discouraged in general, except for low account balances or extreme circumstances.
- Facilitate the regular monitoring and management of longevity risk. Providers of lifetime retirement income should use appropriate and regularly updated mortality assumptions that account for future increases in life expectancy. Public authorities should make regularly updated population mortality data available to provide a reference for setting mortality assumptions. This data should be as granular as possible to facilitate setting appropriate assumptions and the development of sustainable retirement solutions for specific populations; for example, to provide better value to low socioeconomic groups or people in poor health. Standardized data that is publicly and readily available can promote effective risk management and facilitate the creation of longevity indices that can be used to price the transfer of longevity risk to a third party.
- Ensure effective, personalized, regular, consistent, and unbiased communication to plan participants. Communication with plan participants should be clear and simple, with minimum jargon, especially when explaining potential options. It should also be timely and aligned with a purpose. Personalized information through online platforms or statements should, ideally, combine all savings sources and include projections to update members and nudge them to take action to boost their retirement income adequacy. Projections should focus on potential retirement income levels in real terms, account for the likelihoods of different outcomes, and convey risks to plan members. Assumptions and methodology should be fully disclosed. Comparison tools should provide standardized information to allow users to compare performance, costs, investment allocation, and other potential plan features, such as ESG factors. Policymakers should ensure that information provided by financial advisors and digital advisory services is accessible, accurate, and unbiased.
- Promote awareness and support financial education about retirement and pensions. National financial education strategies should be made available that include a focus on raising awareness and knowledge about the importance of saving enough for retirement, the options available, and risks like longevity. Financial education is a continuous process, which should include focused messages that evolve along with savings objectives at different life stages. Public authorities should seek to improve people’s understanding of how the retirement system works and explain retirement reforms, as well as their economic rationale, through various means like communication campaigns. National communication campaigns should be driven by and evaluated against clear, realistic, and well-targeted objectives.
After its upcoming meeting in June 2022, the OECD Working Party on Private Pensions plans to provide technical assistance and policy guidance to policymakers and public authorities for implementing these recommendations.
For these recommendations to be implemented, it is important to recognize how much work has already been done by policymakers and stakeholders to implement the spirit of the Roadmap and enhance retirement security throughout their countries. It is crucial to continue these efforts in the pursuit of sustainability and longevity of defined contribution retirement plans.
Pablo Antolin is the Principal Economist and Head of the Private Pensions Unit, and the Deputy Head of the Consumer Finance, Insurance, and Pensions Division, of the OECD. He also serves as a member of the Georgetown University Center for Retirement Initiatives Council of Scholar Advisors.
April 2022, 22-02
Organization for Economic Co-operation and Development (OECD), “Recommendation of the Council for the Good Design of Defined Contribution Pension Plans,” OECD/LEGAL/0467, February 22, 2022.
Organization for Economic Co-operation and Development (OECD), “Working Party on Private Pensions: Roadmap for the Good Design of Defined Contribution Pension Plans,” May 30, 2012.
OECD, “Pensions at a Glance 2021: OECD and G20 Indicators,” December 2021.