The halcyon days of defined benefit (DB) plans may have been more a mirage than a memory. Here we consider how the retirement income-oriented design of DB plans can inform future defined contribution (DC) plan design – and imagine a new kingdom drawn around decumulation.
The story of Lerner and Lowe’s Broadway musical, Camelot, is set in the medieval, mythological King Arthur era and follows the love triangle between Arthur, Guinevere, and the dashing Sir Lancelot. Underpinning this love story is Arthur’s evolving view of Camelot, initially presented as a utopia but ultimately revealed to be an imperfect place.
"The rain may never fall till after sundown / By eight, the morning fog must disappear / In short, there's simply not a more congenial spot / For happily ever after than here in Camelot"
At State Street we see parallels between this story and the history of DB plans in the United States. That is, some look back at DB plans longingly and remember the time when employees had income for life. But does perception meet reality? In this paper, we highlight some of the shortcomings of DB plans while acknowledging the strengths that we should seek to leverage as DC plans evolve to better address decumulation.
Perceptions vs Reality
1. DB is believed to deliver a high level of coverage and income replacement, but in reality coverage was never comprehensive. In fact, according to Andrew Briggs, a Resident Scholar at the American Enterprise Institute, participation peaked at 39% of employees in 1973; by 1980, only 9% of new retirees in the bottom half of the income distribution were receiving a private pension benefit.i Participation was stymied by the fact that DB plans were largely designed for so-called “full career” employees only. But spending one’s career at one company has long been the exception, not the rule, even for baby boomers. Individuals born from 1957 to 1964 held an average of 12.4 jobs from ages 18 to 54.ii
2. DB is synonymous with guaranteed income in retirement. However, because nearly half of DB participants opt not to annuitizeiii — more so in the context of plan terminationsiv — retirees became responsible for the budgeting-for-life exercise. As supported by EBRI researchv, this can lead to either a savings shortfall or extreme spending restriction, neither of which benefits individuals or markets.
3. DB is assumed to make financing retirement easy, but when it comes to visualizing the journey, from savings to spending, DB plans lack transparency. Statement balances are infrequently shared and the values reflected are more aligned to an actuarial calculation than an accrued savings sum. This is because DB isn’t a saving strategy; it’s a spending solution, one that is hard to integrate into an overall wealth management portrait.
Seeing Camelot with Clear Eyes
Acknowledging that there are gaps in the legacy DB structure gives us an opportunity to create a bridge to new territory. At State Street, we believe the future of retirement income is built on the most successful elements of DB and DC strategies. Namely, the ability to optimize the decumulation experience.
Figure 1: Decumulation Best Practices from DB and DC Constructs
1. Simplified Accumulation Phase
2. Consumption-Based Income Framework
3. Flexible Retirement Age
|Set-it-and-forget-it accumulation||Framed participant benefits in consumption terms (i.e. spending expectations) rather than investment returns, improving annuitization ratesᵛⁱ||
Granted access to income benefits prior to standard retirement age; for example, in the mid-90s, nearly 75% of private sector workers were in DB plans that permitted early retirement at age 55ᵛⁱⁱ
|DC Application||Eased accumulation journey through the adoption of target date funds (TDFs) and additional automation (e.g., automatic escalation and enrolment)||Required lifetime income disclosures on quarterly participant statements are being implemented nowᵛⁱⁱⁱ||
Uncapped retirement age, contributing to the variety of spending needs and financial outcomes retirees faceⁱˣ
|Opportunity for Future Optimization||Extend the simplicity and automation delivered by TDFs to the decumulation phase||Reframe retirement savings as spending and connect the framework to guaranteed income solutions||
Prioritize solutions that offer financial flexibility in the early years of retirement and security through guaranteed income in the later years
Making retirement income easy, practical, and aligned with how people live and age will mark a new era; one that doesn’t just look good on paper but works in practice.
At the end of Camelot, Arthur sings again about the glories of the era but the mood of the song is melancholy, suggesting an acknowledgment of imperfections. It seems that both Arthur as a representation of the old world order and we as an industry have become wiser and possibly receptive to and capable of change. Now is the time to think differently about retirement income, both in terms of objective and implementation.
For many employers, the decumulation objective is to help participants retire when they want to retire but also when the company wants them to retire. At State Street, we believe that retirement income is more than a workforce management strategy, it is a solution that should keep pace with the next generation of employee needs . In fact, the year 2030 reflects a crucial pivot point for the participant population, representing both the year that the youngest baby boomers will reach retirement age, and the onset of the decade in which our 2021 corporate pension survey respondents expect to either exit or wind-down their DB plans. In less than a decade, the DB-ization of DC plans is likely to be in high demand. Is your organization prepared?
iv State Street Global Advisors as of June 30, 2021. A review of plan provisions (which is publicly available, through the form 5500 filings) for plans where a lump sum is regularly available would show that participants are typically expected to elect the lump sum 50% of the time or more.
v Employee Benefit Research Institute’s (EBRI’s) Spending in Retirement Survey; September 2020, https://www.ebri.org/content/why-do-people-spend the-way-they-do-in-retirement-findings-from-ebri-s-spending-in-retirement-survey
viii Interim final regulations were issued in September, 2020 with immediate effect such that calendar year plans are required to include lifetime income disclosures on benefit statements by June 30, 2022. The Department of Labor may issue final regulations in 2022 but we do not expect material changes to the assumptions to be used.
ix Employee Benefit Research Institute’s (EBRI’s) Spending in Retirement Survey; September 2020, https://www.ebri.org/content/why-do-people-spend the-way-they-do-in-retirement-findings-from-ebri-s-spending-in-retirement-survey
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