DC Plans Should Emulate DB Plan Principles

DC Plans Should Emulate DB Plan PrinciplesThe buy-and-hold, “60/40” portfolio strategy was designed for a different era. In the 1950s, an American worker had a reasonable expectation of staying with one employee for his entire career, and receiving a defined benefit (“DB”) pension upon retirement.

Obviously, times have changed, and as more DB plans are frozen or terminated, more American workers are relying on defined contribution (“DC”) plans to provide for their retirement. But since DB plans typically outperform DC plans – sometimes by as much as 1-2% a year – there is mounting evidence that DC plan participants aren’t on track to sufficiently fund their goals.

Lessons From DB Plans

Hence, BNY Mellon’s whitepaper: The DC Plan of the Future: DB Principles for the DC Generation. As is evident by the title, the paper’s authors urge DC plan participants to adopt DB plan principles for their DC plans. The findings it shares were based on interviews with twenty firms that provide DC retirement plans to large U.S. corporations.

“Many of the principles and best practices of DB plans can be used to enhance the performance of today’s DC offerings,” said Dan Smith, BNY Mellon’s head of Asset Servicing for the Americas, in a recent statement. “DB plans typically outperform DC plans, sometimes by as much as two percentage points per year. That’s an important motivator for DC retirement plans to offer asset classes their investors haven’t been able to access in the past. By adding alternatives to their plan, sponsors can provide participants with downside or inflation protection.”

According to the report, the top three priorities to improve current DC plan offerings are:

  • Increasing the use of low-fee institutional vehicles
  • Utilizing alternative investment strategies
  • Generating an income stream during retirement

How are DC plan providers addressing these issues?

  • Thirty-six percent said they plan to make greater use of separately managed accounts (“SMAs”);
  • Twenty-five percent said they plan to introduce private, “white label” funds managed by outside investment managers; and
  • Thirty-six percent said they plan to decrease their use of mutual funds.

“White label” funds typically have lower costs than mutual funds. Lower fees can lead to higher overall returns for plan participants, according to the report.

Retirement Income a Priority

Fifty-five percent of plan sponsors identified providing retirement income an important priority. According to the report, some plans have achieved this by working with insurance companies to wrap annuities into custom target-date funds, but most DC plan participants are uncertain how much they need to invest in order to generate their desired level of retirement income.

“In fact, most employees participating in DC plans are allocating between three and six percent of their salaries, which happens to be the default range on many auto-enrollment DC plans,” said Rob Phillips, senior vice president, Consultant Relations at ‪BNY Mellon Investment Management. “However, 10% is a more realistic number to help employees attain their retirement funding goals.”

For more information, download a pdf copy of the whitepaper.

Jason Seagraves contributed to this article.