The 401(k) plan has only been in existence for 40 years. Originally conceived as a supplement to defined benefit (DB) plans, they have replaced DB plans as the dominant pension plan in the U.S. By necessity, they have evolved over this time to better meet the responsibilities of a primary pension plan. This evolution has resulted in what has been referred to as “DC 2.0.” Some of the characteristics of a 2.0 plan include automatic features, target date funds, participant-friendly investment menus, and retirement income solutions.
As an auditor of DC plans since their inception, it has been both fascinating and encouraging to have a first-hand view of these changes. However, the evolution to the 2.0 plan is still in progress. That’s why a recent study by the Thinking Ahead Institute as highlighted in their paper, “Shifts for the DC Organization of Tomorrow,” caught my eye. The goal of the study was to get an understanding of how DC plans will look in the future (i.e. what “DC 3.0” will look like). The article highlights three findings that provide a glimpse of what characteristics plans of the future may have. The three findings relate to plan consolidation, hyper-customization, and retirement income solutions.
In the U.S., the predominant pension model is centered on single employer plans. The study notes the trend is deviating away from this model, citing the Australian national plan as an example. Additional support for this trend in the U.S. is evident with the recent passage of the SECURE Act. This legislation expands opportunities for the establishment of multiple employer plans (MEPs). This will enable both small and large plan sponsors to provide their employees a pension benefit without the administrative and fiduciary responsibilities associated with a single employer plan. The benefit of this is intuitively obvious for small plan sponsors, whereby they could potentially reap the benefits of scale, while unloading administrative and fiduciary headaches. Large plan sponsors could also benefit from the ability to outsource various plan functions, effectively being able to choose the extent of their role with the plan.
Another item gleaned from the study is the belief that DC 3.0 will be characterized by hyper-customization enabled by technology and more effective participant engagement. Currently, the need for further customization is well-recognized; however, the practical ability to cost-effectively achieve it is an issue. Target date funds (TDFs) have taken a baby step towards customization by factoring the participant’s age in determining the appropriate asset allocation. Without knowing more about the individual, however, the customization is far from optimal. Providers and advisors are currently struggling with how to cost-effectively gather the necessary data to develop a portfolio tailored for an individual’s unique circumstances.
Retirement Income Solutions
With roots as a supplemental pension plan, 401(k) plans emphasized and were managed to focus on asset accumulation, rather than on a retirement income stream. Recently, considerable attention has been given to the goal of providing an income stream, but the needle hasn’t appeared to have moved much. Most of the plans we audit at SLD encourage participants to withdraw their account balances at retirement or, at best, allow for partial or installment withdrawals. While the study seems to acknowledge this current situation, it appears optimistic that things are poised to change quickly. For example, the recently enacted SECURE Act has provisions that eliminate some of the hurdles that have made it problematic for plans to offer retirement income solutions, such as annuities. Also, if headway is made on hyper-customization, as discussed above, this could facilitate the development of retirement income solutions.
Forecasting is always a gamble. No one knows what the future holds. If current trends continue, we might see some of these speculations come true. If so, DC 3.0 plans could have the following characteristics:
- More likely to be part of a MEP than a single employer plan.
- Data aggregation capabilities and participant engagement that allows for customized plans for individual participants.
- Solutions that encompass the entire life cycle (i.e. both the accumulation of assets while working and the drawdown during retirement).