Panel Says "Flaw-ridden" DC Model Needs Help

Current trends are leading to an emerging generation of longer-working individuals forced to become personal “chief investment officers,” according to Matthew Scanlan, head of Americas Institutional Business for Barclays Global Investors (BGI), in a panel last week.

Speaking at an event in New York City, Scanlan said that these individuals were being forced to take on more of the costs and responsibility for their own retirement with what he called a flaw-ridden defined contribution model. He said that this trend was being accelerated by the passage of the Pension Protection Act, the first of phase of a financial overhaul by the Financial Accounting Standards Board (see FASB Publishes Final Standards for Pensions and OPEB at http://www.plansponsor.com/pi_type10/?RECORD_ID=35052) and an anticipated decline in defined benefit plans following the passage of the Pension Protection Act of 2006. According to BGI, 39 companies gave up their DB plans in 2002, 46 in 2003 and 71 in 2004.

Speaking at a discussion sponsored by San Francisco-based BGI Wednesday morning, panelists including Scanlan discussed what the confluence of all of these changes might mean for the future of retirement. The predicted demise of the private sector defined benefit plan (see The Pension Protection Act: This Changes Everything at http://www.plansponsor.com/magazine_type3/?RECORD_ID=34977) will ultimately place a greater responsibility on individuals, who must pick up the slack of responsibility for their retirement future, at the same time a growing number must pay a higher proportion of their current medical costs as well.

Although the DB sector still has a lot of wind left, defined contribution plans have been ushered in as the base of retirement income in the US. However, Barton Waring, head of Client Advisory Group at BGI, argued that these plans still need work and are so far not providing enough for retirement. The average 401(k) balance is $44,000, and those in their 60s have an average of $140,000 to live on in retirement – a figure that is less than half of the Social Security annuity, according to data from the Employee Benefit Research Institute.

No Substitute for DB

Waring said the current DC product is not a good substitute for DB plans, and at this rate, they will not provide enough retirement savings. He warns that the “worst DB plan is better than the best DC plan,” which are “good in theory, but not good in practice.” According to data from the Washington, D.C.-based Employee Benefit Research Institute (EBRI), if individuals begin saving for retirement at age 20, and save consistently for 47 years in a DB or DC plan, the annuities will be substantial at a 4.8% interest rate; however, delaying saving to age 40 or 50 increases the amount workers will need to contribute for retirement substantially, said Dallas Salisbury, president and CEO of EBRI, at the panel discussion.

Waring also argued that investment products for 401(k) plans tend to be expensive and that there are too few options when it comes to DC plans in terms of annuitization of payouts. Annuities were one of the solutions hailed by the panelists to fend off the possibility that retirees will run out of money. Annuities, in which retirees are paid the same amount every month depending how much they saved, “provide a DB-like predictability that they can balance their life on,’ Scanlan said. A report released last week from the American Council for Capital Formation (ACCF) also provides support for the annuitization of 401(k) assets (see http://www.plansponsor.com/pi_type10/?RECORD_ID=35144).

Panelist Olivia Mitchell, from the Wharton School’s Pension Research Council, said that one way to offset the effect of the longer lifespan of individuals on retirement income is by getting them to work a few more years, a move that could have a substantial effect on savings. For instance, workers considered to be in the third wage quintile who retire at age 62 will need 17.3% of additional savings when they retire to smooth consumption; however, if they waited until age 65 to retire, they would only need 7.7% of additional savings. However, Scanlan noted that employees who want to work longer will present a problem for employers, who are then faced with “how to get the next generation of workers into the companies if none of them want to leave,” Scanlan said.

This workforce demographic will affect all types of employers. The changing employee population will create additional educational opportunities and responsibilities for advisers working with plans who have a high population of older workers still needing investment guidance and wealth accumulation in their 60s.