Benefits July 1, 2024

Design Options: Building Strong Retirement Plans

Retirement plan designs that include features and investment options incorporating retirement income into defined contribution plans are a 'good starting point' but can be a ‘blunt force instrument approach.'
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Art by Andrea D'Aquino

Retirement plan design is increasingly focused on getting employees enrolled sooner, keeping them in longer and providing more options for creating income people can rely on in retirement.

The design elements plan sponsors are considering include immediate plan enrollment, lowering eligibility age to contribute, larger arrays of product sets to accommodate decumulation and providing participants with nonguaranteed and guaranteed investments and options to support, converting their accumulated retirement savings into a paycheck in retirement. 

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While defined contribution plans debuted in the 1980s as supplemental retirement savings plans, explains Holly Tardif, a director of retirement and retirement strategist at WTW, different plan design features are needed in 2024 as the remit of these plans has grown significantly and for most U.S. private-sector workers they are now their primary retirement savings vehicles.   

“When we think about the purpose of a DC plan [it’s changed and] some of the conversations that we’re seeing [about what] is the purpose of the DC plan [are] really now far broader than [DC plans were] ever intended to be,” explains Tardif. “[A DC plan] was originally meant to be the supplemental savings plan [to support retirement], and now it’s a primary savings vehicle, source of retirement income for many employees.”

For plan sponsors, pursuing their plan goals requires paying attention to many plan design features, including vesting schedules, eligibility to enroll in the plan and auto-escalation of participant contributions.

“With SECURE 2.0 and other legislation that’s come out, the question now becomes, how do you integrate financial resilience and wellbeing, and retirement income and all these things into plans?” Tardif asks. “[And] how do you communicate that to participants and do sponsors even want that flexibility in-plan is something that we’re having conversations with sponsors about right now.”  

With these trends and changes affecting plan sponsors “[they] have an opportunity to assess their plan to determine if they’re fully meeting their employees’ needs and if their employees are actually optimizing the benefits that are available to them,” explains Catherine Collinson, CEO and president of the Transamerica Center for Retirement Studies.

“The good news is the [Transamerica Center for Retirement Services] survey finds high rates of participation [and] it finds high contribution rates as expressed as a percentage of [participants’] annual pay.”

Plan Sponsor Design Trends

Different plan sponsors have, successfully, added new trends of plan design features to the benefit of the health of their plans. 

The City of Dunwoody, Georgia, recently lowered to 18 from 21 the eligibility age for employees to join the 401(a) and 457(b) plans. Participants are also able to contribute, beginning on the first day of their employment. The city changed the age threshold, after hiring an 18-year-old to work in public safety and because it hoped making the benefit available to younger workers would encourage more young people to apply for municipal jobs.

With average plan deferrals at the Michigan Office of Retirement Services 401(k), reaching 10.7%, the office raised its goal for average deferrals to 15% from 10%, capping the auto-escalation ceiling at the higher rate.  

Per projections by the plan’s recordkeeper, Voya Financial, 61% of the plan’s 401(k) and 457(b) participants are now on track to replace 70% of their pre-retirement income after they retire. The Michigan Office of Retirement Services added its Small Steps automatic escalation program, in 2016.   

The plan sponsor was an early adopter of auto-enrollment among government employers and already included auto-escalation, increasing participant’s contributions by 1% each year unless they opted-out.

In 2023, plan sponsor Wayne-Sanderson Farms—a top U.S. poultry producer—combined three retirement plans into one. The redesigned plan added auto-escalation and enrollment as well. 

With the redesign Wayne-Sanderson Farms’ 401(k) plan employees receive a 100% employer match of the first 4% of their eligible contributions, and they are automatically enrolled and escalated 1% each year up to 10%. 

The asset size of a plan correlates to the sponsor offering auto-enrollment, according to the 2023 PLANSPONSOR DC Plan Benchmarking Survey. It found that auto-enrollment is used by 22% of plans with assets less than $5 million; 45% of plans with assets between $5 million and $50 million; 66% of plans with assets between $50 million and $200 million; 67% of plans with assets between $200 million and $1 billion; and 70% of plans with $1 billion of assets or greater.

For sponsors, mulling over adopting plan design trends, including new features and investment options that include some kind of lifetime/retirement income or guaranteed income, each different employer examines the options based on the plan’s philosophy, says WTW’s Tardif.

Each employer considers the role of the employer and the role of the DC plan differently, she says.

“Some sponsors are going to still think about the DC plan as primarily an accumulation vehicle, and it’s not the employer’s responsibility to help transition that accumulated savings into … an income stream. But there are others—many others—who want to provide a secure retirement income and think the DC plan is a big piece of that solution,“ Tardif says.   

Changing the direction of travel of the DC industry-ship after it has left port, however, is no simple task, Tardif adds.

“Just saying you have option A, B and C, [isn’t enough because] plan sponsors have a really critical role to help show plan participants what their options are, the effects of their choices, and help them truly make the right decisions for themselves,” she explains.  

“DC plans have always meant to accumulate, and we spent a lot of time on that, as an industry, helping participants accumulate wealth, but not as much focus on decumulation,” she adds. 

For sponsors, starting the conversation with their participants about retirement income options by addressing Social Security claiming strategies is a good place to begin, explains Collinson.

“One [way] is through their plan provide education about Social Security benefits, how to how to think about them, how to plan for them and how to access the Social Security… website to keep track of their vested benefits,” says Collinson. “Plan sponsors can help do that. They can also provide ongoing news updates or education when there are any major developments about Social Security.”

Pam Hess, executive director of the DCIIA Retirement Research Center, agrees with Collinson, adding “people think [Social Security is] disappearing, and that if they don’t claim it now, they’re never going to get it, and that fear is doing them a disservice.”

Trends Specific to Decumulation

Retirement plan design trends and features to include options, supporting participants to secure retirement income, specifically are at a starting point with providers focused on developing products to incorporate into target-date funds.

The use of annuities with the design of DC plans to generate guaranteed income remains concentrated on products packaged as either default options for plan sponsors to position inside their qualified default investment alternatives, often within TDFs that serve as the QDIA.

For plan sponsors with nonguaranteed options, securing combined lifetime income or retirement income blends have focused towards in-plan design features like allowing systematic withdrawals, but those are not ubiquitous. The feature is ripe to be expanded because plans have not embraced partial withdrawals across the board.  

The retirement recordkeeping and investing industry is “at a good starting point with this kind of blunt force instrument approach,” says Yaqub Ahmed, co-head of U.S. investment-only business and global retirement strategy lead at Franklin Templeton Investments. “It’s a good … jumping off point, but there’s a lot of things we can do to advance it today, not tomorrow.”

In 2024, recordkeepers and asset managers have begun offering products and features to meet demand for retirement income or guaranteed income and launches are likely to continue at a robust pace as demand climbs. According to an internal survey of Voya plan sponsors clients, in the large corporate plan market segment, nearly half of sponsors have identified retirement income and income drawdown solutions as a critical area of focus. Also, the results of the 2023 annual participant research showed strong interest in retirement income services and solutions, says Laurie Lombardo, vice president at Voya Financial, responsible for leading development of new products and services for tax exempt markets. 

“From the plan participants who do not currently have such a solution, more than 70% of these plan participants are very or somewhat interested in retirement income plan options, with people of color showing even a stronger interest,” found the Voya Consumer Insights & Research, 2023 Retirement Plan Participant Experience survey conducted from June to July 2023 among 6,176 participants in employer-sponsored retirement plans managed by Voya.

Annuities Ahead?

Plan sponsors must beware of potential pitfalls, pursuing the option of adding in-plan annuities to offer guaranteed retirement income, says David Blanchett, managing director, portfolio manager and head of retirement research at PGIM DC Solutions.

“One potential issue with [adding] annuities in DC plans is you don’t know how many folks are going to actually annuitize and use the benefit,” he says.

For plan sponsors, Blanchett cautions, “If I’m a plan sponsor and I am going to include as a default, an annuity in the target-date fund, what percentage of my participants do I want to annuitize? Is that 20% is it 50% and then what happens if it’s only 1%?”

For plan sponsors who are determined to add in-plan annuities Blanchett is also concerned there are long-term implications, which cannot be unwound readily because annuities “are not as simple as a normal investment,” he explains.  

“If the [plan sponsor’s investment] committee [prior to the current leadership], for some reason, loved emerging market debt, [for example], but then the new committee hates it, you can just get rid of the fund: No big deal. If you’ve allocated to an annuity based upon the type of annuity, you can’t get rid of it as easily,” explains Blanchett.  

With in-plan annuities, sponsors are “creating something that’s very sticky longer term, which, again, …could be a very good thing, but just be aware of what you’re doing to make sure you’ve got every other kind of thing that’s easier already covered,” he adds.

Beyond Products

In-plan annuities are one way to provide participants with options to secure income in retirement.

For plan sponsors, “there’s hundreds or thousands of different ways,” to offer participants options to secure lifetime and retirement income—“embedded within” TDFs, with product launches to continue explains Blanchett.

Before adding annuities or other new features plan sponsors “need to look at their plan document” because “the plan document may not allow systematic withdrawals,” adds Lombardo. “The plan document may not even allow a partial distribution.”

For sponsors, using an outdated plan document may prevent additional features.

“That’s the best place to start, because modernizing the plan document to have some of these key features like systematic withdrawals and partial distributions—if you don’t have those—blocks the participants from doing any kind of paycheck conversion at all,” says Lombardo. “Plan sponsors can start simple, and then as they get comfortable, they can certainly add as they go.”

Focusing too narrowly on plan designs, using annuities and TDFs will “miss,” significant portions of plan participants because not every plan participant invests their retirement assets in TDFs, adds Drew Carrington, senior vice president and head of institutional DC at Franklin Templeton Investments.

“If you’re designing a solution that where the only way you can get income is inside a target-date fund, you may not be targeting the people who most need that because you’re going to miss them,” he explains.

Benefits June 3, 2024

Now It Is About Protecting Healthy Funded Levels

Higher interest rates since 2022 have put corporate pension funds at their highest funding levels in many years, prompting plan sponsors to consider options to hold onto the gains and limit their risk.
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Art by OYOW

Corporate defined benefit pension plan sponsors have a singular opportunity to evaluate if their plans are in a position to offload liabilities using pension risk transfer or allocate to strategies with less risk, including liability-driven investing, reviewing their options to best provide pension benefits to the participants to whom they were promised at the lowest cost for the company going forward.

Separate Milliman and Principal Asset Management research on pension plan funding finds sponsors have room to now accelerate de-risking—as the funded status of many has improved to reach fully funded and near-to-fully funded status—to protect funding levels.

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The funded status of the average U.S. corporate pension plan “sits around [the] 105% level, so it’s over funded,” explains Owais Rana, head of investment solutions at Principal Asset Management.

“It is therefore an opportune time for pension plan sponsors to take risk off the table, particularly the investment risks to begin with, and then start considering whether it makes sense to further de-risk their balance sheets by embarking on a pension risk transfer strategy or maintaining the obligations on their balance sheets, also known as hibernation by de-risking their investment strategy.”

State of PRT Market

The U.S. pension risk market was estimated to have $14.6 billion, in the first quarter of 2024 compared to the previous Q1 record of $6.3 billion in 2023 and nearly triple the 2022 figure of $5.3 billion, finds a Legal & General Retirement America May 2024 market update.

The pension risk transfer market is expected to remain strong, according to Cerulli Associates research.  

“Over the last handful of years, we’ve seen pretty historic pension risk transfer activity, and across the board, [survey respondents] felt like it was going to continue, regardless of where interest rates have gone,” says Chris Swansey, associate director, institutional, at Cerulli Associates.

More than two-thirds of plan sponsors (69%) said they are at least somewhat likely to de-risk over the next 24 months, found Cerulli in research conducted in the second quarter of 2023, published in May. 

“Over the last handful of years, we’ve seen pretty historic pension risk transfer activity, and across the board, everybody felt like it was going to continue, regardless of where interest rates have gone,” adds Swansey. “Funded statuses have improved dramatically, and a lot of plan sponsors are looking at fully funded or surplus funding. So that kind of creates an opportunity … we’ve also had a number of new entrants into the insurance space, and that’s driven down costs.”

Pension Funded Status Research

In 2023, three of the top 100 U.S. pensions reached a funded ratio greater than 140%; one achieved between 135% to 140%; and two plans each were within funding ratios of 130% to 135%, 125% to 130% and 120% to 125%, according to Milliman research.

Almost 50, nearly half of the companies within the Milliman data set reached fully funded levels, explains Zorast Wadia, principal and consulting actuary at Milliman.

“[It] only improved in the first four months of 2024,” he says. “So, I would think that now more than half of the largest U.S. plan sponsors are at or above full funding levels.” 

In total, 69 plans are between 95% and above 140%, finds the Milliman 2024 Corporate Pension Funding Study. The study tracks public companies with the largest DB pension plan assets for which a 2023 annual report was released by March 10, 2024.

“[It’s] an important place to be for pensions because we haven’t seen these types of funding levels for a decade and a half,” explains Wadia, co-author of the study. 

In 2023, the average funded ratio of the 100 pension plans tracked by Milliman decreased slightly to 98.5% from 99.4% at the end of 2022 and the 7.2% investment return was not enough to pace the growth

“A deficit of $19.9 billion this year put corporate DB plans of the Milliman 100 companies within striking distance of achieving full funding,” Milliman researchers wrote.

In 2023, the pension deficit of the Milliman 100 companies rose to $19.9 billion from $8.5 billion, Milliman reported.

For sponsors, with healthy funded levels the focus often shifts to measures to protect funding, says Wadia.

“The whole emphasis of [corporate DB sponsors] should be right now to make sure to lock in these gains: You don’t want history to repeat itself, like in the late [19]90s [when] pension plans were in a great position,” but did not protect the gains, he says.

Corporate pension funds should learn from past mistakes, Wadia adds.

Timing

Rana and Sri Reddy, senior vice president of retirement and income solutions at Principal Financial Group, say the timing is right for corporate DB sponsors by swapping out equity-like exposure for fixed income assets, Rana wrote in a post online, earlier this year.

“What I ask CFOs and CEOs is, ‘What is the relative size of your pension obligations relative to your current earnings?’” says Reddy.  “That’s a good proxy” for the risk the pension funding declining could add to a business.

The de-risking strategies available to sponsors include lump sum payments, particularly to participants who are near retirement; and full or partial pension risk transfers, according to Rana. 

“From my perspective, [de-risking in ways we recommended] would allow plan sponsors who have been waiting for this point to sleep well at night,” explains Rana.

For sponsors, following Principal Asset Management’s recommendation to de-risk would almost entirely “defease most of their investment risks relative to liabilities,” he adds.   

With the blueprint, “[plans] haven’t eliminated [the investment risk]—[because] the only way to do that is with a pension risk transfer, but they have defeased a significant amount of risk out of the system and now the companies can concentrate on their actual business as opposed to spending ,” Rana says.  

Wadia agrees that de-risking portfolios will require exploring reallocating plan assets to lower-risk assets and liability-driven investment strategies. 

“LDI is the strategy that makes sense if you want to sleep well at night, if you’d want to minimize interest rate risk and investment return risk,” he says.

Learning their lessons from the past, sponsors do not want to surrender healthy funded level gains, Wadia adds.

“[LDI] is essential as your funding status improves, you want to move away from risky investments, i.e., equities and go into fixed income,” he explains.

Using LDI, sponsors allocate to fixed income portfolios, “matching your liability payout stream—your [plan’s] unique payout stream—to your plan.”

Plans with full funding or that are close to fully funded, de-risking to lock-in gains will address, Rana adds.

“[Sponsors] need to seriously start to match the interest rate risk of the liability and sell some of that equity risk to reduce the overall mismatch between assets and liabilities,” says Rana.

He clarifies that while the Federal Reserve may start to cut interest rates this year, that would have little effect because “short-term rates will have very little to no direct impact on liability valuations,” adds Rana.

Factors to Consider

Corporate sponsors, protecting healthy funded levels, should base their decisions to de-risk, reallocate or offload liabilities on the overall health of their plan, says Rana.

“[There is] no one factor … there are a few factors, which are … going to be very unique and specific to each plan sponsor,” he explains.

Open plans that are accruing benefits require a distinct strategy from a closed plan, for example, explains Wadia.

“Do you still have a highly leveraged final average pay plan design that many would consider a dinosaur plan? These plans have very aggressive accrual patterns, and are highly leveraged, so participants entering later years of service—the benefits can really move off the charts and so with the newer types of plan designs like cash-balance plan designs, and variable-annuity plans, there’s a deeper level of risk sharing between the plan participant and the sponsor.”

The interest rate sensitivity of a plan’s liabilities is also an important factor to consider, adds Rana.

The longer-dated obligations are the more sensitive the assets are going to be to interest rates, Rana says, “hence, [sponsors] must explore the LDI component far more than an obligation that’s going to be of a two-year duration, for instance [because] the interest rate risk [of the asset] is not that much.”

Another factor, “and one of the most important ones,” is the strength of the company and its ability to withstand bad market events, says Rana.  

Declining equity markets and lower “long-end” interest rates will affect sponsors, flipping sponsor’s funded status toward a less healthy position, he adds.

“Are companies in a position to bear that risk, which translates into future contributions that they will have to make into these plans? A lot of the companies that have defined benefit pension plans have been industrial companies. If you look at the universe of those companies that have the strength to withstand these events, [it] is going to be very low, which means that they are better off de-risking … as opposed to being to be forced to divert capital away from shareholders into a pension plan in the future,” Rana says.

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