How to 'DB-ize' your supplemental DC retirement plan.

• Author: Sanford, Paula
• Position: Defined benefits - Defined contribution

Reduced revenues and growing demands for services have led governments to examine the financial sustainability of their retirement plans, resulting in widespread pension reforms. According to the National Conference of State Legislatures, 43 states have implemented substantial changes to their pension plans in 2009-2011, as have numerous local governments. Many of these changes will reduce employees' pension income in retirement, and some employees with shorter tenures will no longer have access to the benefit. To offset these and other related impacts, many public employees will need to supplement their savings. As a result, supplemental defined contribution plans -- plans that are not intended to be the primary retirement savings vehicle for employees--will be more prominent than previously, when they were used as extra spending money or to pay for a retirement dream like travel or a boat. In the future, supplemental plans will likely become a critical component to meeting basic needs such as rising health-care costs and housing, in addition to issues such as personal debt reduction.

THE 'NEW FACE' OF RETIREMENT

The primary goals of recent pension reform legislation have typically been to reduce costs and employer risk, adjust to the needs of a more mobile workforce, and equalize benefits between the public and private sectors. Most of the reforms have focused on amending the defined benefit plan itself and have fallen into four primary categories:

* Increasing defined benefit contribution levels for current and/or new employees.

* Increasing the age and/or length of tenure required to be eligible for normal retirement.

* Reducing or eliminating cost-of-living adjustments for new and/or current employees.

* Changing the way pension formulas are calculated to reduce pension benefits.

Additionally, some states and local governments have begun offering hybrid (1) and primary defined contribution plans to replace the traditional defined benefit plan. For example, the states of Georgia, Utah, and Rhode Island have all adopted hybrid retirement plans for new employees within the last few years.

At the same time, the "new face" of retirement is adding to the importance of having additional retirement savings. The retiree who has paid off his or her mortgage, is an empty nester, and has limited medical expenses is not always an accurate portrait of today's workforce. More frequently, retirees are carrying debt into retirement, have children or grandchildren living with them, are facing rising health-care costs, and must plan for multiple decades in retirement. In these circumstances, what once was considered a very adequate defined benefit pension may simply be insufficient.

Acknowledging the growing importance of defined con tribution plans, finance and human resources staff in the public sector have begun to analyze how to encourage greater participation in supplemental plans and to improve savings outcomes. They have looked at behavioral economic theories and the successes and failures of the private sector 401(k) world. Much of the effort centers around making defined contribution plans look more like defined benefit plans, referred to as "DB-ization." Under this approach, plan design takes into account the limited experience and interest many employees have in regards to their own retirement savings and incorporates several tools that can ease decision making for employees.

PLAN DESIGN

DB-ization is an outcomes-based approach to defined contribution plan design that attempts to achieve an adequate retirement income for workers through adoption of specific plan components, strong employee communication, and acceptance of participant behavior. Design features seek to increase savings during employment by investing a higher percentage of salary, selecting appropriate investment strategies, and limiting leakage from the plan. Some DB-ization tools may be more appropriate when defined contribution plans serve as the primary retirement income mechanism (i.e., core plans), while others are appropriate for both supplemental and core plans. We will discuss the most common tools and why they may or may not work for your organization's supplemental defined contribution plan.

Auto Enrollment. Under auto enrollment, employees are automatically enrolled in the employer's retirement plan and must opt out if they don't want to participate. This is the opposite of the traditional enrollment method, which has employees opt in. Generally speaking, the latter enrollment method has not been particularly effective at increasing participation rates, while the former can have a very strong...