Employers that use defined-contribution pension plans may be willing to do more to help their employees accumulate a decent income in retirement. From making it easier to choose investments that will generate sufficient income to helping people be realistic about their retirement income goals, DC plan sponsors are offering new tools to assist their plan members.

More and more companies are selecting DC pension plans or group RRSPs, collectively known as capital-accumulation plans, as the predominant retirement plan for their employees. In such plans, employers and employees contribute a percentage of the employee’s earnings to a fund, and the employee selects the investments — generally from a limited range of funds offered by the employer. At retirement, the amount in the fund is used to purchase a pension or is rolled over into a RRIF.

Although such plans are based on the employee assuming the responsibility for retirement provision, it seems that increasing numbers of employers recognize employees may need help to make the most of these plans and turn them into good sources of retirement income.

While there is little firm data in Canada on the topic, a new survey from San Francisco-based Charles Schwab & Co. Inc. focusing on 401(k) plans, reveals that senior finance executives in the U.S. believe a partnership between employer and employee is important, “not only for ensuring the employee’s financial well-being over the long term, but also for attracting and retaining a productive and motivated workforce.” (A 401(k) plan is a DC plan named for the section of the U.S. Internal Revenue code under which it is established, and is the U.S. equivalent to an RRSP.)

According to Schwab’s report: “Helping employees understand the long-term benefits of participating in a plan and adopting strategies to balance financial commitments can be key to weathering cyclical financial storms and keeping employees pointed in the right direction toward reaching their retirement savings goals.”

Most respondents to the survey gave their employees only a “C” grade in financial literacy — that is, the employee’s ability to make informed decisions about his or her long-term financial future. According to the report, respondents believe “employers should take at least some responsibility for educating employees and providing them with help and guidance.”

Says Jim McCool, executive vice president with Charles Schwab corporate and retirement services: “It is also clear that the employers feel it is no longer enough to simply make a 401(k) plan available and leave employees to their own devices. A team effort is required, with employers doing all they can to get their workforce on the right track and employees taking full advantage of the tools their company provides.

“In general,” he adds, “employees need help finding answers to three basic and deceptively complex questions that must be explored to form the basis of a sound and informed retirement savings strategy. One: ‘How much do I need to save?’ Two: ‘Where should I invest my savings?’ And three: ‘How much money will I have in retirement?’

“A good advice program, offered through an employer,” he continues, “helps answer those questions.”

While the move to CAPs is not nearly as advanced in Canada as it is in the U.S., there are signs Canadian employers are also looking at ways to help their employees make better use of these plans. Among other things, says actuary Ian Genno, principal with benefits consultants Towers Perrin in Toronto, employers are concerned with managing risk in their CAPs.

However, Greg Hurst, principal in the Vancouver pension consulting practice of Morneau Sobeco and leader of that firm’s national DC consulting practice, observes that some features of the U.S. system don’t work very well in Canada because of fundamental differences between U.S. and Canadian regulatory requirements and tax rules. For example, enrolment in a CAP plan in Canada requires the employee’s signature, so features such as the automatic enrolment used by some U.S. employers to get employees into their 401(k) plans are problematic in Canada.

According to Nigel Branker, senior consultant with Towers Perrin in Toronto, plan sponsors are looking at providing fewer investment options for plan members to choose from.

“If you offer too many options, people can be overwhelmed by choice,” Genno adds. “That can result in poor investment decisions by plan members.”

@page_break@Plan sponsors who used to offer a money market fund as a safe — but low-return — default option for employees who found it difficult to select an investment fund, are moving to options such as target-date funds instead. Such funds, in which maturity is based on the date when the employee wants to retire, change the mix of assets to become more conservative as the target date approaches. And they generally offer a better rate of return than money market funds.

Although target-date funds are supposed to take the guesswork out of investment choices for pension plan members, they also have their drawbacks. For instance, as Hurst points out, asset mix in most target-date funds is based only on age of the plan member and not on his or her risk tolerance. As well, he says, employees who choose a target-date fund often also allocate some of their investments to other options, thus defeating the purpose of the target-date option.

Hurst believes options that do not include an investment choice for DC-type plans can be a good alternative in many cases. He suggests sponsors of CAP plans should offer a balanced fund only. “But sponsors would need to demonstrate due diligence,” he points out. “In my experience, when employees don’t have any choices, they’re much happier with their plan.”

Branker notes that some employers with CAP plans are starting to look beyond the capital-accumulation period to see what will happen to employees upon retirement. Plan sponsors are now revisiting their plans, he says, and taking a critical look to see what else is needed to make sure the plans deliver an adequate retirement income to employees.

Genno says that employees in these plans face three types of post-retirement risk: individual-based investment risk, inflation and longevity risk. Plan sponsors are thinking about how they can help plan members understand these risks and how the employers can equip plan members to address them.

According to Hurst, the use of matching employer contributions is proving to be an important way to get employees involved in their CAP plans. Matching formulas are quite common in Canada — and more generous than they are in the U.S., he says. The most common formula in Canada, he says, involves the employer matching employee contributions dollar for dollar, although, he notes, employer matching is not always as effective with lower-income employees, who may feel they can’t afford to contribute.

And while Hurst believes financial literacy has probably improved a lot over the past two decades, it is still the primary problem. “Employers have a huge challenge to address this,” he adds.

Genno notes that the 2005 CAP guidelines issued by the Joint Forum of Financial Market Regulators contain a checklist for employers and are designed to ensure members of CAP plans get the help they need to make informed choices about their investments.

Communications with plan members are also improving, says Hurst. Plan statements are becoming simpler to read and online communication now allows employees to factor in additional information so they can see whether their retirement income plans are on track.

Such tools are also becoming easier for plan members to use, Genno adds. IE