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A Syntheti(k)SM Pension Plan

By Stephen J. Lansing CIMC, CEBS, President and Founder of Sentinel Fiduciary Services, Inc. of Orlando, Florida, one of the few independent professional ERISA fiduciaries in the Southeast. If you would like to discuss this issue further, you may contact Steve by email (stevel AT sfs.cc) or call him at 407.246.7221.

"Man's mind, stretched to a new idea, never returns to its original dimension." ---Oliver Wendell Holmes

For more than 50 years the US pension system has served the public well. It has helped millions of Americans secure a comfortable retirement. Automatic participation, little or no worker involvement, protection from premature distributions, professional investment management, and annuitizing retirement benefits are the characteristics of pensions worth maintaining.

However, all is not well in the defined benefit world. In 1974, 44 percent of all private-sector workers were covered by a defined benefit plan. By 2003 the participation had dwindled to 17 percent. [Historic Statistics, Employee Benefit Research Institute, April 28, 2004] The PBGC estimates that corporate plans are underfunded by as much as 450 billion dollars. Watson Wyatt recently reported that in 2004, 11 percent of Fortune 1000 companies that had a defined benefit plan had either frozen or terminated it, up from 6 percent in 2002. A bellweather event was IBM's decision on January 5, 2006, to freeze its pension. We are in a completely different environment than the one that spawned and nurtured the orthodox defined benefit plan.

The differences between today's benefit world and the paradigm that arose in the last half of the past century are obvious and rather stark. Academics are starting to make serious note of the problems.

The private pension system faces numerous problems. Coverage has stagnated at about 50 percent of the labor force for the last thirty years. Employees with low wages and those who work for small businesses have extremely low rates of coverage. Pension rules and regulations have become enormously complex and quite possibly counterproductive. [The Trends, Evolving Effects, Pension and Proposals System for Reform, W.G. Gale, J.B. Shoven, and M.J. Warshawsky, editors (2005): vii]

Critical issues negatively affecting pensions include an adverse legislative environment, obtuse accounting rules, arcane actuarial practices, a challenging investment arena, a fluid and demanding workforce, and a financial press that is prone to exaggerate issues, both pro and con. [The Broken Promise, D.L. Barlett and J.B. Steele, Time in Depth, Oct. 23, 2005] There is no rational basis to allege that the conventional defined benefit plan is still effectively serving most sponsors and their employees. If a sponsor cannot use its plan to recruit, reward, retain, and retire employees, the program will, at best, languish.

Additional proof of the sea change taking place is the prevalence of self-directed defined contribution plans. In the last 25 years, 401k plans have emerged to be the dominant new retirement plan adopted in the for-profit sector. At the end of 2004, there were about 43 million participants in 401k plans with over $2.1 trillion of assets. [ICI 2005 statistic "The Influence of Automatic Enrollment, Catch-up, and IRA Contributions on 401k Accumulations at Retirement," EBRI Issue Brief #283, July 2005] Growth in 403b and 457 plans shows similar success. Yet, the common defined contribution plan is not yet achieving its purpose of being a viable replacement for the pension system. Approximately 80 percent of employees who are eligible participate in 401k plans. [48th Annual Survey of Profit Sharing and 401k Plans, Profit Sharing Council of America, p. 21] Those who do contribute defer a woefully inadequate amount of savings. The majority of participants are prone to making major blunders in their investment decisions.

These circumstances were being discussed years ago. In 1993, Rodger F. Green, a partner with Greenwich Associates, wrote in Pension World [p. 28]:

Lurking deep within the fundamental underpinning of defined contribution plans are two structural weaknesses that will likely combine to prevent these plans from fulfilling their promise. One, the asset mix of these plans is too conservative and lacks adequate diversification. Two, asset mix decisions are entrusted to the person least able to make and sustain the right mix for them--the employee.

Similar alerts and instructions appeared later in the decade:

One approach to enhancing today's 401k structure, which could benefit both employers and employees, would be to offer participants a choice of active involvement (by self-directing a brokerage account) or passive involvement (as part of a professionally managed pool). ["A New Alternative for 401k Plan Structuring," D.L. Wolfe and M.S. Falk, Employee Benefit Journal (Dec. 1998): 25]

Brooks Hamilton, one of my fellow co-founders of the ERISA Fiduciary Guild (www.fiduciaryguild. org), has been a visionary and thought leader in this area for some time. Considering their early dates, his articles: "A Fork in the Road" [Journal of Pension Benefits, Fall 1999] and "Reinventing Retirement Income in America" [NCPA Policy Report 248, Dec. 2001] are enlightening reading about the evolution, and resulting failure, of the pension system. It is amazing how long good ideas take to resonate in the pension community.

The pension profession would probably be in a frustrated state of indecision and static practices had it not been for the emergence of the new field of behavioral finance. Thanks to Dr. Daniel Kahneman and his Prospect Theory, Shlomo Bernatzi and Richard H. Thaler with their SMarT (Save More Tomorrow) Plan, as well as substantial research by organizations like The Pension Research Council, The Center for Retirement Research, and the Vanguard Center for Retirement Research, we now have an objective, rational basis for applying practical knowledge of human behavior to plan design and management. The result of melding the disciplines of psychology and economics is facilitating a more functional way of managing defined contribution plans.

I have coined the term "Syntheti(k)SM Pension Plan" to represent the codification of these developments. The creative and intelligent application of behavioral finance can guide a sponsor in designing and running a self-directed defined contribution plan so more of its core attributes resemble those of a pension plan. Plan design is the first prime factor in determining the success of a defined contribution plan.

Employers can try to escape making tough decisions about how and how much employees ought to be saving for retirement by giving employees choices and letting them decide for themselves. However, even this type of laissez-faire plan design will itself influence outcomes relative to other design choices that could have been made. In short, there is no escape. ["Plan Design and 401k Savings Outcomes," J.J. Choi, D. Laibson, B.C. Madrian, National Tax Journal Forum on Pensions (June 2004): 21]

Restating this proposition in a different way, 401k, 403b, and 457 plans can be made to exhibit many of the favorable characteristics of a defined benefit plan from the employee perspective without the pension plan's convoluted and counter-productive elements. Lest you think I am the only inhabitant in the asylum consider these:

DC (defined contribution) plans can yield benefits to retirees competitive with those provided by DB (defined benefit) plans, if investments are well managed and if the employees contribute enough money to the plans. Sadly, neither of these conditions is generally true today. [Mind the Gap, Barclays Global Advisors]

When viewed from the perspective of retirement benefits for employees, the selection of the investment options is less important, and in some cases much less important, than other issues, such as participation (through making deferrals), the level of deferrals, the asset allocations behavior of participants, and so on." ["The Fiduciary Duty to Administer a Successful Plan," F. Reish and B. Ashton, a white paper for Ameriprise Retirement Services, p. 4]

If defined benefit plans are on their last legs, then it would make sense to try to incorporate their best features into 401ks. The drawback to 401ks, remember, is that people are imperfect savers. They don't save enough, they don't invest wisely what they do save and they don't know what to do with their money once they are free to withdraw it. Quite often they spend it." ["The End of Pensions," R. Lowenstein, The New York Times, Oct. 30, 2005]

Transposing Actuarial Science to the Management of a Defined Contribution Plan

Basic actuarial principles can be used to support and execute the concept of a "Syntheti(k)[SM] Pension Plan." In its most elementary state, each defined benefit plan has a pension liability for each participant. Indeed, one of the most simple, conservative actuarial cost models is the individual aggregate method of determining pension expense. With this methodology, each person's funding cost is determined individually. Conceptually, even the aggregate liability of a large pension can be viewed as being the simple sum of each individual aggregate cost calculation. There are numerous reasons why large plans use more sophisticated methods for computing costs, but this elementary cost technique is what links foundational actuarial principles to a Syntheti(k)[SM] pension plan.

By definition, every pension plan has one investment strategy and asset allocation model regardless of the number of participants, their ages, tenure, pay scales, turnover, actuarial cost method, etc. Complex mathematical formulas in the form of asset liability studies can be used to refine the investment mix to best meet the aggregate emerging liability. From a fundamental perspective, a pension can be viewed as a compilation of each employee's retirement expenses funded with an aggregate pool of assets.

A self-directed defined contribution plan could be cast in the same fashion as this simplistic pension strategy. All it would take to apply routine defined benefit planning to a defined contribution plan environment is the ability to make rudimentary determinations of each person's private pension liability and match that cost with a broadly diversified professionally managed pooled funding vehicle. Fortunately, today's modern technology available from the leading service providers makes the operation of this strategy possible.

A self-directed defined contribution plan could be viewed as a derivative of a defined benefit pension plan. Not only can 401k, 403b, and 457 plans be made to replicate a pension in the eyes of the participants but it should be managed with the same professional and independent oversight that defines "best fiduciary practices." In this regard, ERISA does not draw any distinction between defined benefit and defined contribution plans.

The 12-Step Path Towards Improved Plan Management

1. Establish a Prudent Control System for Fiduciary Governance

The foundation of sound plan management is building and executing a strategic blueprint for plan governance. The subject is serious enough that Secretary of Labor Elaine Chao said in a recent address to the Yale School of Management:

The time has come to move the focus of pensions out of the human resources department and beyond compliance with tax laws. The executive level suite needs to focus on pension plan governance itself, especially the responsibly and liability of pension plan fiduciaries.

She was informing executives of the significant role they have in overseeing their company's retirement plans. Indeed, Black's Law Dictionary defines a fiduciary as having duties involving good faith, trust, special confidence, and candor towards another. Referring to prominent ERISA legal cases, [Donovan v. Bierwirth, 680 F.2d 263, 272 (2d Cir. 1982) and Bussian v. R JR Nabisco, 223 F.3d 235, 294 (5th Cir. 2000)] the Department of Labor in its ENRON Brief reminded the public that the responsibilities of fiduciaries are "the highest known to the law."

These steps begin with proper formation and empowerment of a committee that will serve as Named Fiduciary. It includes following a thoughtful charter, carefully organizing quarterly meetings which include an annual business plan, and compiling copious minutes. Not to be ignored is the careful delegation of duties and responsibilities to subcommittees and prudently selected providers, the ongoing education of committee members and the regular examination of fiduciary liability insurance and indemnification agreements. Institutional fiduciary management is emerging as a new and distinct profession.

2. Engage an Effective, Cooperative, and Proactive Service Provider

The third-party administrator is integral to executing the committee's agenda for making the plan as effective as possible. Gone are the days of myopically focusing on a provider's recordkeeping technology, enrollment booklets, quality of proprietary funds, etc. The vendors on the leading edge of contemporary plan management will have distinctive attributes. The staff that services the plan should be dedicated, experienced pension professionals. The provider's perspective and resources should facilitate the dynamic use of the principles of behavioral finance. Its investment platform must not provide just for open investment architecture but must be able to facilitate the sophisticated use of model portfolios including commingled trust instruments tailored for each plan. The cost of running the plan will continue to be important but criteria that define requisite services are rapidly changing and becoming multi-dimensional. Effort and resources should be channeled to the areas of plan management that truly make a difference. A first class administrator is a catalyst for making the plan function effectively.

3. Thoughtfully Design the Contribution Allocation Formula

A defined contribution plan can never "duplicate" the benefit accruals of a defined benefit plan, but it can come preciously close, if desired. Consider target benefit pension plans. For determining contributions this design can virtually duplicate defined benefit plans. They use actuarial cost methods and can accommodate final average salary formulas. Even past service benefits and permitted disparity can be utilized.

Cross-testing methodologies, permitted under Code Section 401(a)(4), can be applied to shape deposits in a more focused manner than even target plans. Indeed, in certain ways the flexibility of cross-testing techniques facilitates more useful ways of channeling contributions to better meet corporate objectives. Conceptually, if a group of employees has fallen behind in accumulating retirement funds, they can be classified to receive extra contributions. Some corporate contributions are necessary with these strategies but defined benefit plans rarely have deposits of less than 3 percent of pay. Modest company payments can be taken on gradually and offset by using a small portion of future pay raises.

Admittedly, some "front loading" of benefit accruals in defined contribution plans cannot be avoided. But that would be a small price to pay for the added investment risk the participants incur with a defined contribution program. Plan contributions would not have to increase. And it would be good for companies to limit using terminated employees indirectly to help fund older and longer-term workers' retirement costs.

4. Automatically Enroll Employees

By now few people dispute the effectiveness of implied consent for enrolling employees. A recent PLANSPONSOR/Prudential survey found that 88 percent of sponsors agreed that automatic enrollment was worth the effort. ["Reinventing the Defined Contribution Plan: Research, Analysis and Recommendations," Prudential Financial White Paper, p. 5] It is common knowledge that participation usually increases at least 10 percent when automatic enrollment is properly used. The Profit Sharing Council of America reported in a recent web cast that 66 percent of employees would be more likely to participate if automatically enrolled. ["The Evolution and Future of Default Option," The Profit Sharing Council of America, Oct. 20, 2005, slide 5] Over 90 percent of "Generation Y" adults acknowledge that it is important to save for retirement. ["'Generation Y' Attitudes and Perceptions," Diversified Investment Advisors Survey, Nov. 2005] A surprisingly few people opt out of the plan if they are included in this manner.

When Americans do save for retirement, most don't consider it a burden at all. In fact, about 80%, across age, income, and each of the ethnic/racial backgrounds, hardly notice the "lost" spending opportunity and ultimately feel happy about their savings toward tomorrow's security. ["Road Blocks to Retirement," Prudential's Four Pillars of Retirement Series, 2005, p. 15]

On February 20, 2006, the Retirement Security Project and the Heritage Foundation formally proposed the creation of a "universal IRA." The foundation of this concept is automatic enrollment in IRAs for employees of small companies. Automatic enrollment is one of the few dynamic ways a sponsor can clearly demonstrate sincere interest in their employees' well being at retirement. To use a vacation metaphor, workers need a tour guide, not just a travel agent.

5. Escalate Deferrals

Research shows that far too many people get stuck at the deferral percentage established with automatic enrollment, usually 3 percent of compensation. Indeed, evidence exists that many participants take the plan design features as tacit advice from their employer. Because the reality is that all but the youngest people cannot retire with enough income unless they defer multiples of the default amounts, deferrals should be gradually increased until they at least reach the ceiling for matching contributions. Studies show that automatic increases are well received by participants, with over half saying they would be more likely to contribute if savings percentages were increased. ["The Evolution and Future of Default Option," The Profit Sharing Council of America, Oct. 20, 2005, slide 5] Academic studies support the PSCA's findings.

With the erosion of traditional defined benefit pension plans and the growth in defined contribution vehicles, sound retirement planning increasingly depends on the commitment of individuals to invest in tax-deferred retirement accounts throughout their working lives. Policies that encourage higher participation and contribution levels throughout workers' careers could significantly enhance retirement security. ["Lifetime Patterns of Voluntary Employee Pension Contributions," K.E. Smith, The Retirement Project, Number 4, Nov. 2005, p. 1]

The escalation could be tiered by age and account balance so late starters have their savings regularly increased to 15 percent, or more, of pay. Regularly raising savings rates aligns automatic enrollment with effective retirement guidance.

6. Default Investments into a Professionally Managed Account

Defined contribution fiduciaries should duplicate common investment practices in pension plans by using an institutionally managed pooled account.

Policy makers concerned that not all employees want or are able to handle critical investment decision would do well to reassess the current structure of self-directed 401k programs. For instance, participants might be allowed to choose between self-direction of their assets in a 401k plan and entrusting those decisions to professional asset managers. Amounts in the individual accounts of participants who choose the latter approach could be placed in a common investment trust. ["Changing Risks Confronting Pension Participants," P.C. Borzi, Pension Research Council Working Paper 2005-14, p. 14]

A collective trust specifically built for a plan can provide investment vehicles and strategies impossible to obtain in a conventional mutual fund: "If pension assets are concentrated in a single pooled trust, the plan fiduciary can hire professional advisors to provide this expertise. By contrast, DC plan participants may not have access to the same level of expertise at comparable cost." [Id. at 9] Those who understand behavioral finance know the problem employees have with making sound investment decisions: "The literature on psychology of consumer choice and the results of many surveys on financial literacy both suggest that choosing an asset allocation is the real stumbling block to making a participant election." ["Trends and Issues," The TIAA-CREF Institute, Oct. 2005, p. 6]

Providing an alternative to failing ERISA Section 404(c) compliance is another reason to use a default election described in this step: "The 404 (c) 'defense' is not needed for participants who are invested prudently because there is no violation to defend against. In my opinion, the best defense is a good offense. That is, the primary focus should be on improving participant investing." ["A Good Defense, The Limitations of 404(c) Protection," F. Reish, PlanSponsor, Oct. 2005, p. 96]

Repeated DALBAR studies prove that the return of the S&P 500 index routinely betters the average stock investor by three percent a year or more. [Quantitative Analysis of Investor Behavior, Dalbar, 2005, p. 16] In most years the investment returns in large pension plans exceed the aggregate return of participants in self-directed plans, in many periods by 2 percent or more. Yearly returns in self-directed defined contribution plans that exceed those of pensions do so with exponentially larger risk.

Time-tested "best practice" investment concepts utilized in large pension plans should be available to participants. All the risks commonly associated with investing can be better managed through a pooled account in the form of a common trust. The major costs of investing can be better managed and lowered with a collective trust. Professional allocation decisions involving asset class utilization and manager selection are more productively accomplished with a pooled investment vehicle.

7. Use Model Portfolios to Facilitate Prudent Asset Allocation for Those Who Self-Direct Their Accounts

Expansive, convoluted investment menus can be simplified by melding the many individual options into a few model portfolios. The portfolios can be used to focus the employee investment decision by offering them discrete and understandable allocation choices that are automatically rebalanced: "Adding a life-cycle option increases the likelihood that newly eligible employees will participate in their plan from 39% to 45%." ["Life-Cycle Funds Mature," Vanguard Center for Retirement Research, Nov. 2005, p. 1]

Model portfolios facilitate crafting the use of actively managed concentrated mutual funds that can "complete" intelligently designed diversification strategies that use index funds as the investment foundation. This technique assures prudent diversification, effective use of investment professionals, and content participants. Also, studies show less than 15 percent of people rebalance their accounts more frequently than annually and as a result they are obtaining inferior returns with more risk. ["Defined Contribution Plans: Missing the Forest for the Trees?" Putnam Investments, Oct. 22, 2005, slide 23].

The contemporary use of model portfolios is being discussed and considered more often: "More specifically, we envision offering an appropriate risk/ return-balanced range of five or six model portfolios comprised of low-cost, broadly diversified and automatically rebalanced passively managed mutual funds designed in accordance with leading academic research to be both prudent and diversified." ["A Step Beyond ERISA Section 404 (c): Improving on the Participant Directed 401k Investment Model," J.C. Chang, W.S. Simon, and G.K. Allen,Journal of Pension Benefits, Summer 2005, p. 8] Model portfolios are often a better alternative to the majority of LifeStyle or LifeCycle mutual funds, which are generally more expensive, difficult to understand, and problematic to monitor. Care should be taken when age-based solutions are used. Can fiduciaries prove that age alone, without input from the participant, reasonably correlates to a prudent mandated investment strategy?

8. Prudently Offer Investment Advice by a "Fiduciary" to the Plan

As discussed, a sound principle of fiduciary risk management is the intelligent delegation of responsibility to professionals. One practical example of this is making available investment advice to participants. By now we should understand that participants desire support with their investment decisions. Fifty percent of 30 and 40 year olds answered affirmatively to the statement "I wish a retirement expert could just tell me what to do about saving and planning for retirement." ["Roadblocks to Retirement," Prudential's Four Pillars of Retirement Series, 2005, p. 14] "Most Americans are unaware of their financial vulnerabilities, and they lack knowledge, sophistication, and/or authoritative guidance required to set them on the right track." [From a 1998 study by Bernheim in "The Importance of Financial Communication for Participation Rates and Contribution Levels in 401k Plans," S.A. Nyce, Pension Research Council Working Paper 2005-03, p. 1]

This should come as no surprise when Harry Markowitz, the winner of the Nobel Prize in Economics and the father of modern portfolio theory has been quoted as saying: "I should have computed the historic covariances of the asset classes and drawn an efficient frontier. Instead I split my contributions fifty-fifty between bonds and equities."

Fiduciaries must remember the selection and monitoring of an advice provider is a fiduciary decision that will be more important than managing the investment menu. Any firm so engaged must demonstrate its product is defendable under scrutiny and must absolutely accept fiduciary responsibility for its advice. The cost of the service is also a critical factor. Investment advice is becoming a product that is rapidly turning into a commodity. If sponsors use discretionally managed options it may be best done with an advice provider who uses any fund it chooses rather than just the offerings on the menu. If other techniques such as model portfolios are properly used, sponsors may not desire the added complexity and cost associated with this service.

9. Properly Educate Participants

The vast majority of people are not risk-averse investors, they are loss-averse savers. All but a handful of employees are essentially unwilling or unable to assimilate enough financial information properly to be effective investors and retirement planners. So education efforts should be focused on supporting constructive behavior rather than changing detrimental proclivities. Workers should be encouraged to accept plan design features and operational provisions that guide them through actions they freely admit to desiring but all too often fail to effectively implement. "Many survey respondents desire a new approach that makes retirement more simple and accessible. They want more education and training and more objective recommendations about how to save and plan." ["Roadblocks to Retirement," Prudential's Four Pillars of Retirement Series, 2005, p. 19]

Department of Labor Bulletins state the importance of giving employees income replacement goals, information needed for building personalized goals, and resources to design a strategy to reach those goals. ["The Fiduciary Duty to Administer a Successful Plan," F. Reish and B. Ashton, White Paper for Ameriprise Retirement Services, p. 7]

Financial resources should be channeled into more productive endeavors. From the Seventh Annual Transamerica Retirement Survey, October 2005, we learned that 67 percent of the non-participants said the reason they were not participating is their inability to save. Budgeting (spending) workshops are more important than investment seminars. Studies show matching contributions only increase participation between 5 percent and 10 percent. "Generous match rates enhance participation by the lower-paid, but do not do much to increase plan-wide savings rates. Overall, employer 401k matching contributions are an imperfect vehicle for advancing broad-based retirement security objectives." ["Better Plans for the Better-Paid: Determinants and Effects of 401k Plan Design," O.S. Mitchell, S.P. Utkus, and T. Yang, Pension Research Council Working Paper 2005-5, abstract]

10. Limit "Leakage" from Plans (Hardships Withdrawals, Loans and Pre-Retirement Distributions)

It is a shame that even after the major hurdles of participation, adequate deferrals, and sound investing are overcome, retirement savings can still be dissipated because of premature draw downs. These culprits are not necessary to improve plan utilization. A GAO report on loan availability finds that participation rates in plans with loans are just 6 percent higher than ones without loans. ["Trends and Issues," The TIAA-CREF Institute, Oct. 2005, p. 11] Other findings are somewhat contradictory but still conclusive: "Providing greater liquidity through a loan feature has no impact on plan participation, but it does raise plan contribution by about 10 percent among non-highly paid participants."["Turning Workers into Savers? Incentives, Liquidity, and Choice in 401k Plan Design," O.S. Mitchell, S.P. Utkus, and T. Yang, Pension Research Council Working Paper 2005-18, p. 3]

As far as early distributions are concerned, the picture is not encouraging. The 2001 Federal Reserve's "2001 Survey of Consumer Finances" finds that 55.2 percent of participants cashed out lump-sum distributions when they changed jobs. Another recent study by Hewitt Associates found that 45 percent of workers cash out their 401k's after leaving a company. Additionally: "Only 17 percent of individuals who received lump sum distributions at ages 25-29 rolled them over. By contrast, 56 percent of individuals who were older than 60 when they received the distribution rolled it over." ["Changing Risks Confronting Pension Participants," P.C. Borzi, Pension Research Council Working Paper 2005-14, p. 7]

A rational case cannot be made for abusive hardship, loan, and distribution practices. If a defined contribution plan is the sole or even the significant retirement program, facilitating withdrawals sabotages the plan's purpose and needlessly adds to its cost and complexity.

11. Offer Immediate Annuities to Retirees

From 1983 to 2001 male life expectancies at age 65 have increased 1.7 years and female longevity has gone up .6 years. [US Social Security Administration, 2005] People are living longer but are not adjusting their retirement plans to reflect properly the lengthening need for financial security. In his November 23, 2005, Wall Street Journal article, Jonathan Clements said: "immediate-fixed income annuities, which can provide lifetime income in exchange for a lump-sum investment, are possibly retirees' best bet for squeezing maximum income out of their retirement savings."

Though too many people are ill-equipped to manage long-term retirement income needs, the sponsor community is finally recognizing the problem.

Plan sponsors are starting to worry whether they are doing enough, now that an increasing number no longer offer DB plans, to prepare employees for a potentially long retirement with fewer safety nets. Yes, they have been providing education on savings and more investment options in their defined contribution plans, but do their participants have the knowledge to make their savings stretch over an indeterminate life span? Plan sponsors suspect not, and many are beginning to investigate vehicles that will assist their employees with the challenge. The most popular is one that has faced serious bad-mouthing in the past--annuities. ["Inventing the Stretchable Retirement Dollar," S. Kelly, Treasury and Risk Management, Oct. 2005, p. 1]

Make no mistake: Increasing health care costs in retirement will aggravate this situation. Most people should annuitize some of their retirement income so that regardless of advancements in medical care and bad investment decisions, there will always be a floor of income they cannot outlive.

12. Monitor/Audit the Entire Process

What may first come to mind is overseeing the investments. Fortunately, more and more defined contribution plans are establishing an institutional process for watching the assets. This same discipline should, however, be applied to other areas of a plan's operation. The conclusion segment of Putnam's "Defined Contribution Plans: Missing the Forest for the Trees?" provides an excellent summary.

  1. The DC industry needs to refocus its energies on the actions and metrics that matter the most in helping participants accumulate retirement wealth.
  2. Fund performance has historically been "front and center" in terms of most discussions. This misses the point.
  3. Nobody is saying that the performance of the underlying funds is not important, it's just that many other variables are at work (participation is a given):
    • Deferral rates;
    • Diversification/asset allocation;
    • Rebalancing behavior;
    • Age-appropriate changes; and
    • Individual fund performance.

The oversight process must be both procedurally and substantively prudent: "The requirements consist of 'procedural prudence,' which is the process of conducting the investigation, evaluating the data, and making decisions, and 'substantive prudence,' or the duty to make a reasoned decision, that is, a decision reasonably based on relevant facts." ["The Fiduciary Duty to Administer a Successful Plan," F. Reish and B. Ashton, White Paper for Ameriprise Retirement Services, p. 10]

A lot of effort and resources can be wasted on unproductive issues and tasks. A mission statement should be written and used to help avoid squandering the precious time of fiduciaries. Why do you have the plan in the first place? The true answer to that question will be instrumental in guiding the committee to truly productive and meaningful actions.


"The important thing is to continue questioning." --Albert Einstein

Dallas Salisbury, the CEO and president of EBRI, said "Americans are chronically optimistic about their retirement prospects." This confidence is misguided when you consider some other statistics from EBRI studies:

  • 31 percent allocate their retirement plan accounts by either random guessing or dividing their assets equally among the investment options available;
  • 44 percent do not think they can save an extra $20 per week;
  • 61 percent of employees have not determined how much money they will need to save for retirement; and
  • 83 percent of participants have never rebalanced their plan accounts.

Another academic study puts it this way: "Most 401k's place substantial burdens on workers to understand their financial choices and assume a certain degree of confidence in making such choices. Many workers shy away from these burdensome decisions and simply do not choose. Those who do choose often make poor choices." ["The Automatic 401k: A Simple Way to Strengthen Retirement Savings," The Retirement Security Project, 2005-1, p. 3]

David Wray, the president of the Profit Sharing Council of America, has said that profit sharing plans should be run so that, even if the participants don't do anything the outcome is favorable. To elaborate:

A guiding principle for policy design should be to make the new system as easy and safe for workers as the old one. Under traditional pensions, workers could avoid making most financial choices relating to their pension until retirement.In current 401k plans, however, workers face many financial choices (as well as the risk associated with those choices) but many lack the expertise to choose soundly. In response, policy makers and employers could reform the system to save employees from having to be financial experts, while continuing to allow self direction for employees who want it. ["Improving 401k Investment Performance," W.G. Gale, J.M. Iwry, A.H. Munnell, R.H. Thaler, Center for Retirement Research issue brief number 26, Dec. 2004, p. 6]

When these findings make their way into the mainstream press be assured they no longer represent some arcane proclamations from the ivory towers of higher learning. In her article "No More Hard Choices," in the Wall Street Journal on July 19, 2005, Ruth Simon articulates the obvious:

The rise of no-worry programs reflects a growing concern that many workers aren't doing a good job of managing their 401k's. More than 30% of eligible workers never sign up for their plan, according to a study by benefits consultants Hewitt Associates in Lincolnshire, Ill. Many who do enroll don't save enough, or they make poor investment choices. And they never revisit their investment choices once they make them, even when changing circumstances or large stock market moves throw their asset mixes out of whack.

Lastly, Abby Johnson's presentation to Pensions & Investments Defined Contribution conference on February 27, 2006 could not have been better support for the principles that represent the Syntheti(k)[SM] Pension Plan. She provided additional academic background for all of the behavioral finance aspects of this solution path. The earlier people participate in retirement plans, the less action they are required to take, the more they are encouraged to keep money in the plan until retirement, the better investment support they get and the more they are encouraged to guarantee some lifetime income the better off all the stakeholders in the US retirement system will be.

So, for the average employee we believe by carefully designing and intelligently operating a defined contribution plan it can take on the favorable nature of a defined benefit pension plan. This would be a good thing for most people. Deloitte Consulting stated in its 2006 annual "Top Five Total Rewards Priorities" survey that 53 percent, the largest response, of employees said that the most important personal issue for them was their ability to have an affordable retirement. Far more people than you would imagine just want to hear "don't worry; we will take care of it." Sponsors need to give people a choice not to choose, an optional path to financial security.

This article was first published in the Journal of Pension Benefits (Publication Date: June 22, 2006). Reprinted by permission of the author.


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