THOUGHT LEADERSHIP

Retirement Income as the Outcome

Why defined contribution plans should be reframed

Plan sponsors and their recordkeepers believe that a focus on retirement income will be one of the biggest retirement practice trends to emerge in the next several years. PLANSPONSOR spoke with Robin Lenna, executive vice president of MetLife’s Corporate Benefit Funding group, which includes the company’s institutional retirement business, and Jeffrey R. Brown, the William G. Karnes Professor of Finance at the University of Illinois College of Business, about the qualified retirement plan system and what plan sponsors should consider as they seek to ensure that their plans provide successful retirement outcomes for plan participants.

PS: In recent years, some have called into question the adequacy of the U.S. retirement system. What role do qualified plans play in helping to ensure retirement security for American workers?

Brown: Employer-provided plans are essential to the retirement security of American workers. About four out of every five full-time workers have access to an employer-provided plan, and individual retirement accounts (IRAs) are an available option to those who do not. More than just providing access to a plan, however, the employer is often viewed as a trusted intermediary who can help employees navigate the complex waters. Absent that trusted intermediary, the average worker would find it too overwhelming to navigate the thousands of products in the marketplace.

Lenna: I completely agree. Qualified retirement plans are the most efficient way for employers to provide retirement security to their employees. Defined benefit (DB) pension plans and defined contribution (DC) plans are often underappreciated and play a significant role in supplementing Social Security, a program that was never designed to be the sole source of retirement income for most Americans.

PS: What impact has the steady decline in the prevalence of defined benefit plans had on workers’ retirement security?

Lenna: For many workers today, a defined contribution plan is their only significant retirement program, and the shift away from traditional defined benefit plans has put increasing pressure on DC plans to be a major source of retirement income. The 2014 Retirement Confidence Study (RCS), released in March by the Employee Benefit Research Institute (EBRI), found that while only 19% of retirees say employer-sponsored retirement plans such as a 401(k) are a major source of income in retirement, the percentage rises to 42% for current workers who believe these plans will be a major source of retirement income.

Brown: That’s right. Overall retirement plan coverage rates are not so different today than they were in the heyday of DB plans. The key difference is that individuals have to take more responsibility for their own planning in the current environment. Recent changes—such as auto-enrollment, auto-escalation and the prevalence of diversified default options—have made the defined contribution plan a much better substitute for the defined benefit plan than was the case a decade ago.

One key difference with the shift from DB to DC, however, has been the corresponding decline in annuitized income streams. In the old days, defined benefit plans almost always provided benefits in the form of guaranteed lifetime income that could not be outlived. Today, DB plan participants are increasingly taking lump sums, and many DC participants do not even have an in-plan option to convert their wealth to guaranteed income. This needs to change, because the average retiree would have improved retirement security if he had the tools needed to guarantee that he will not outlive his nest egg.