The decline of defined benefit plans and the rise of defined contribution plans have created dilemmas for both plan sponsors and participants. Although they had their own disadvantages, DB plans make saving fairly easy for participants; DB participants are automatically enrolled and don’t have to make any investment decisions. With the growth of DC, much of that responsibility has shifted to participants, with mixed results. However, there are steps DC plan sponsors can take to seek the best of both the DB and DC worlds. By incorporating aspects of defined benefit plans into a DC plan design, plan sponsors can strive to address the following problems that many DC participants face:
- Low enrollment
- Inadequate contribution rate
- Inappropriate asset allocation
Nine Steps to DB-izing a DC Plan
- Automatic enrollment: Behavioral finance research shows that it is essential to encouraging participation. Don’t set the default contribution rate too low. Many plans are auto-enrolling at a 3% default rate. That’s likely to be inadequate to generate sufficient savings in retirement.
Tip: Auto-enroll at 6% or more.
- Automatic escalation: Participants are unlikely to revisit their contribution rate on their own. Automating is key.
Tip: Auto-escalate at 3% or more.
- Thoughtfully select and evaluate a QDIA: Target date funds, balanced funds and managed accounts are options.
Tip: Consider employee demographics, fees and the asset-class mix at retirement.
- Re-enroll participants: Many participants do not know how to appropriately invest. Re-enrolling into a QDIA can help address that problem.
Tip: Have participants reconfirm their investments. Communicate the process thoughtfully and frequently to ensure success.
- Streamline the number of investment options: Research shows that offering too many options can paralyze participants. Reduce the number of options.
Tip: Consider reorienting the lineup based on the three tiers in the following hypothetical example.