Good News for Defined Benefit Plans is Not Always Good News for Defined Contribution Plans

All plan sponsors should remain vigilant for opportunities to more effectively leverage the value of their retirement plans

TORONTO, Sept. 11, 2013 /CNW/ - Helped by market gains and rising long bond yields, traditional Defined Benefit (DB) plans are now showing improved solvency following several years of increased deficit-funding by plan sponsors. The news, however, may not be as good for defined contribution (DC) plans.

The latest DC Retirement Index from professional services company Towers Watson (NYSE, NASDAQ: TW) -- a benchmark that shows the effect of changes in capital market returns and annuity purchase prices on the potential retirement income of a Canadian worker in a DC plan -- shows only a slight increase in monthly pension - from a low of 13.4% of monthly wage in Nov 2012 to just 15.2% as of September 1, 2013. When compared to the high of 22.3% in December 2007, it's clear that DC plans continue to struggle.

Ian Markham, Canadian Retirement Innovation Leader at Towers Watson, said "While both DB and DC plans have benefited from improved market gains, differences in funding design have contributed to the difference in relative performance.  One important distinction is the opportunity for de-risking. DB plan sponsors have been able to use improving financials to consider de-risking strategies to lock in a portion of the recent market gains. However, DC plans do not have access to the same opportunities and will not benefit as readily from the same market gains."

"Another contributing factor in the performance disparity, is the fact that, unlike with DB plans,  DC plan sponsors don't make extra contributions to make up for poor performance in past years, which can result in significant deficits relative to the plan members' expectations, " explained Michelle Loder, Canadian DC Business Leader at Towers Watson. "Given these fundamental design differences, the onus remains on DC plan members to increase their contributions in times of poor investment performance or accept a lower level of accumulated savings from which to draw retirement funding."

A Growing Disconnect and Missed Opportunities
As DC plan retirees grapple with the reality that the heady days of 2007 are long behind them, DC plan members in mid-career are growing increasingly concerned about their retirement future. Canadian employers, however, appear disconnected from that reality.  According to Towers Watson's 2013 Pension Risk Survey, 78% of respondents who sponsor a DC plan say that retirement security has become a more important issue for mid-career employees over the last three years. However, only 23% of the participating DC plan sponsors expect their pension plans to play a bigger role as a part of their organization's total compensation strategy over the next five years — and 18% expect retirement plans to play a lesser role. 

The scale of the potential missed opportunity for a DC plan change is evident from the data available through Towers Watson's Benefits Data Bank. Over the past five years, there has been very little change in maximum employer and employee contribution levels to DC plans. The employer contribution rates for close to 75% of the plans in the data bank have remained unchanged. However, some organizations are re-examining the ability of their DC plans to provide a target retirement income in the context of the new economic reality. Seventeen percent of plan sponsors in the Benefits Data Bank have increased their maximum employer contributions, from an average of 5.1% to 7.3% of pay.

Michelle Loder concluded, "For DC plan sponsors, the notion that market improvements may not be "good-enough" news for DC plans has been a bit slow in coming, but now is the time to take notice.  A DC plan that may have been designed for a different economic environment can have a negative impact on workforce planning and operational efficiencies if plan participants cannot accumulate enough savings to retire."

About The Towers Watson DC Retirement Index
The Towers Watson DC Retirement Index tracks the effect on retirement income of members in a defined contribution (DC) pension plan as a result of changes in capital market returns and annuity purchase prices. The benchmark retiree is a 60 year-old member who retired in December 2007, after 20 years of contributing a consistent annual percent of pay into the plan, with those contributions having been invested in a balanced fund (half in equities and half in bonds). That benchmark retiree's pension amount (as a percentage of final pay) is compared to the pension amount of later retirees who would have the same 20 year contribution history and asset mix. If investment performance over a particular member's 20-year history is worse (or if annuity purchase prices at retirement are higher) than those our benchmark retiree had experienced, this member will receive a lower percentage of final pay as retirement income from the DC pension plan.

About Towers Watson
Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. The company offers solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Towers Watson has 14,000 associates around the world and is located on the web at towerswatson.com.

SOURCE: Towers Watson

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