Defined Contribution Plans: Looking Ahead To 2021

Helping employees get back on track on the road to retirement

2020 has been an unprecedented year, and as it comes to a close, defined contribution plan sponsors are starting to look ahead to 2021. Taking a cue from the medical field, we recommend that plan sponsors focus on the following “resolutions” in preparation for the New Year:

1. Triage: Focus on those participants who have been most affected by Covid, namely those who have made Coronavirus Related Distributions (CRDs) and hardship loans. 
2. Address the underlying causes of financial instability, not simply the symptom: Focus on the overall financial wellness of their entire workforces.
3. Provide tools for lifetime income: financial advice, effective communication materials, facilitating employees’ transition from worker to a retiree. 

Success is Personal 

Saving for retirement is a multifaceted problem where, in a defined contribution world, participants ultimately are responsible for their own success or failure. While there are advantages of being enrolled in a defined contribution plan, such as clear tax advantages and easily comprehensible plan provisions, employees carry the risk. That is why we believe that success is personal. 

A plan sponsor can provide tools, such as selecting a well-run qualified default investment alternative (QDIA) like managed accounts or a target-date fund and encourage beneficial financial decisions, like automatic enrollment and auto-escalation options in their defined contribution plans. Throughout the pandemic and the financial crisis that ensued, most participants took no action regarding their retirement savings;¹ they did not change their savings rates, they remained invested in the QDIA, and they did not take a CARES Act distribution. With the market recovery that we are currently seeing, most participants’ account balances have recovered to pre-crisis levels. Therefore, many plan sponsors can take solace in the fact that most of their participants have weathered the storm very well.
 

However, for those participants that did take a CARES Act Distribution—one Fidelity study cites CARES Act Distribution Activity between April 1, 2020, and September 30, 2020, representing 4.7% of participants²—and/or reduced their savings rates, the impact on their retirement readiness could be significant. We would advise plan sponsors to produce a targeted analysis on those participants and suggest a custom recovery plan. 

For example, say an employer suspended the employer match in the 401(k) plan as of April 2020; some participants may have reduced their savings rate in response to this change. As the market starts recovering, the employer has resumed the match. Did those participants who reduced their contribution respond and increase their match to its pre-Covid level? For those participants who did not, the plan sponsor could provide very targeted communication to encourage them to return to their prior savings levels. 

Most troubling to us is the issue of CARES Act Withdrawals. These are dollars that are lost from the retirement savings, or leakage. The Federal Government provided tax relief through the elimination of excise tax and deferral of income tax. However, if these withdrawals are not repaid within three years, the individuals will then face a current income tax bill. 

Plan sponsors can help by providing these individuals with a customized recovery plan and by encouraging repayment of these withdrawals within three years. Communication is key, so it is important that plan sponsors effectively convey the dangers of withdrawals and how to avoid a heavy tax bill. These targeted efforts can have a tremendous impact on their retirement readiness. Remember: success—and failure—is personal.

Overall Financial Wellness – It Matters

If 2020 has shown us anything, it is that our defined contribution retirement system is interconnected with all areas of participants’ financial wellness. Stress in one area will produce a response in another, especially for those already struggling. For example, a 2018 survey found that 6 out of 10 millennials can't afford a $1,000 emergency.³ About a third of Americans are still in debt from borrowing money for a previous financial emergency; of those who still hold these debts, a little more than 30 percent owe $5,000 or more and almost twenty percent owe more than $10,000.⁴
 
For the most at-risk workers, the Covid-19 crisis added significant financial stress. While the availability of CARES Act distributions helped some people make ends meet, the impact of this crisis will be felt for a long time to come. Plan sponsors who only consider the impact of Covid-19 on retirement savings risk overlooking the root cause of participants’ financial stress. In medical terms, one would only be treating the symptom (reduced retirement readiness) while ignoring the underlying causal factor (e.g. lack of emergency funds, high debt burdens, etc.). 

Proactive employers will look to address their employees’ overall financial wellness. Financial wellness programs can help employees set up expense budgets, establish emergency funds and provide resources to help achieve overall financial wellness. These programs also help workers move in the direction of reducing their high-cost debt and effectively managing their other financial obligations. 

Retirement Income

How do 401(k) participants turn their account balances into real retirement income? This has been a crucial question for the past decade. Now is the time for fiduciaries to really focus on the needs of their participants who are entering retirement and how best to help them be successful. 

Almost forgotten in all the craziness of 2020 amid shutdowns, vaccines, and a presidential election was that the SECURE Act became law on December 20, 2019. A major part of this legislation included provisions to encourage lifetime income from defined contribution plans. Specifically, the SECURE Act includes provisions covering the following:
 

• Disclosure of Lifetime Income: Shows that a defined contribution account balance can be converted to lifetime income.
• Fiduciary Safe Harbor for Selection of a Lifetime Income Provider: Provides a safe harbor for fiduciaries that provide a lifetime income product.
• Portability of Lifetime Income Options: Provides clear guidance to support robust portability features of lifetime income products.

While the SECURE Act clearly provides support for plan fiduciaries to include insured lifetime income products within their 401(k) plans, only time will tell if this will foster more adoption. 

In the meantime, all plan fiduciaries face the issue of how to help their plan participants transition from the accumulation phase to the decumulation phase—and a lot can be done now without the additional fiduciary burden of adding insured products. Many plan sponsors are actively encouraging their former employees to leave their account balances in the plan. 

To help these retired participants during the decumulation phase, plan sponsors are actively looking at systematic withdrawal plans supported by managed account services. To better support these participants in the decumulation phase, fiduciaries may want to consider additional asset classes to better support these retirees. Some in the industry are calling for a “retirement tier” of investments tailored to the specific risks and needs of retirees. 

Overall, with the backdrop of the SECURE Act, many plan sponsors are being inundated with a variety of insured products to better support lifetime income. We recommend that plan fiduciaries analyze the needs of their participants, decide on long-term objectives for retirement income, review the marketplace for products and services, and select the best options to meet their own needs and objectives. 

Conclusion 

The Covid-19 pandemic has caused international distress on physical, mental, and financial levels. While government efforts on both federal and state levels have provided short-term relief for workers, many Americans will face long-term consequences, such as delayed retirement, increased need for higher deferral rates and emergency savings, and loan repayments. There are, however, ways for employers to help their employees get back on track on the road to retirement. 

By focusing on the financial wellness of those employees who were most affected, addressing underlying stressors, and providing employees with adequate resources and communication, employers can move in the direction of ensuring retirement readiness for their employees.

Notes

	Daniel Cassidy, FSA, CFA, is Senior Vice President and Senior Consultant at ProManage, LLC.  Visit https://promanageplan.com/  Connect Daniel Cassidy
	Meghan Malachi is a Consulting Analyst at ProManage, LLC.   Connect Meghan Malachi