By Steve Charlton
It’s too early to say if the recent changes in UK pension legislation will lead to better decisions by pension scheme members. But for us in the pensions industry, the changes have focused attention on how schemes need to be designed to ensure the best outcomes for participants.
Our recent research into pension schemes of multinational companies found plan design is crucial when resolving retirement challenges. Our survey of over 90 multinational companies (with an aggregate $650bn in defined benefit and defined contribution plan assets) showed that a modern DC plan is emerging globally. Features of this new kind of plan include some responsibility shifting back from employee to employer, better investment outcomes through improved plan design and investment options, and fee transparency to help drive costs lower.
Shifts in responsibility
The move from DB to DC meant the burden of responsibility switched from the employer to the employee. The fact that 71% of respondents expect to increase employer contributions to their DC plans either dramatically or somewhat over the next five years shows that employers remain committed to providing adequate retirement solutions.
But employers are also realising they have a responsibility to deliver well designed schemes that will improve investment decisions and retirement outcomes. In this sense, the newly emerging modern DC scheme blends elements of DB and DC.
Improved plan design
With DB, the retirement benefit was clearly defined, little effort was required by the employee, and there were safeguards and incentives to keep members on track for a secure retirement. To mirror these characteristics, DC plans have adopted automatic features such as auto enrolment and auto escalation. These features are now mandatory in some countries. They are designed to ensure not only that scheme members are saving for retirement, but that they’re also saving more over time.
Target date funds (TDFs) are another DC-type feature in which asset allocation decisions are left to professionals rather than the member. This is similar to a fiduciary management service employed by some DB schemes. Our survey found that 66% of DC schemes prefer to use a TDF as their scheme’s default investment option. Usage is high in the US, with about two-thirds using off-the-shelf TDFs and another 13% using custom TDFs. However, outside the US, where customised lifestyle and fund of funds options have also gained traction, only 30% of plans use them. Structural and regulatory differences could explain the slower adoption rate of TDFs in these markets.
Fee transparency
The ability to monitor and understand the costs of a DC plan is a key concern, with 79% of schemes identifying fee transparency as one of the most important decisions when choosing whether to use a bundled or unbundled approach. We expect scrutiny of fees will continue and that this will put further downward pressure on costs.
With greater awareness of a scheme’s overall expenses, many employers are seeking lower-cost service and investment options. So it’s unsurprising that a majority of plan sponsors (57%) want passive funds to play a part in their default fund structure and 38% prefer all-passive, while very few (5%) prefer an all-active line-up for their DC default fund.
A modern DC scheme emerges
Vanguard’s survey into the challenges faced by multinational plan sponsors highlights how DC plans are evolving. As employers adopt more of a shared-responsibility approach to retirement, DC schemes are being designed to improve contribution levels. But increased funding will not help if employees are left to make poor investment choices. To combat this, schemes are incorporating default options, such as target-date funds, to ensure better retirement outcomes. We can also expect the push for fee transparency to continue and leading to lower costs and greater use of passive mandates as a result.
Steven Charlton is DC proposition manager, Europe, at Vanguard
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