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The Retirement Plan Solution: The Reinvention of Defined Contribution

ISBN: 978-0-470-49480-6
256 pages
June 2009
The Retirement Plan Solution: The Reinvention of Defined Contribution (0470494808) cover image
Praise For The Retirement Plan Solution

"Short, clear, complete, and always interesting. Best book on DC plans and what we should do-now."
Charles D. Ellis, author, Winning the Loser's Game

"At a time when the world is in turmoil, along with retirement expectations, the authors have hit a home run. After reading this book, I have a plan. Read it for your path to retirement security."
Dallas Salisbury, President and CEO, Employee Benefit Research Institute

"The Retirement Plan Solution offers a refreshing and provocative perspective on how to assess retirement needs, save to meet these needs, and manage the retirement payout process. In this time of financial turmoil, employees, plan sponsors, and financial advisors will find this highly practical resource volume both useful and humorous."
Olivia S. Mitchell, Director, Pension Research Council, Wharton School

"The Retirement Plan Solution is a map to the future of 401(k) retirement plans. But it is not just a theoretical view of what could be. Instead, the authors describe the needs and trends that are already here, and then describe the changes that are developing to meet those needs. It is about the tomorrow that is happening today."
Fred Reish, Managing Director, Reish Luftman Reicher & Cohen

"The respected authors have created a readable, timely, and very helpful book on all aspects of retirement planning. The suggestions are practical, the information is concise, and the book is highly recommended for anyone that is interested in sound financial planning."
Moshe A. Milevsky, PhD, Finance Professor, York University, Toronto, Canada

"This is a must-read for people working in the retirement industry, as well as those who simply care about how to improve their chance of reaching a financially secure retirement. In a clear and simple fashion, the authors deliver one of the best books to date on inefficiencies in the current DC plan and potential improvements."
Peng Chen, President, Ibbotson Associates

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Preface xiii

Acknowledgments xix

INTRODUCTION

The Great American Retirement System? 1

Defined Benefit and Defined Contribution 2

The Dynamics of the Retirement Plan 3

Room for Improvement in the Accumulation Phase 4

The Right Sort of Education 5

Other Ways of Running Defined Contribution Plans 6

The Individual’s Role in Decumulation 7

The Plan Sponsor’s Role 8

A Final Thought: From Biggest to Best 9

CHAPTER 1 DC Version 2.0 11

Coming of Age 12

The New Retirement Superpower 13

Coming Soon to a Dictionary Near You: DBization 14

At the Heart of Version 2.0: A Different Objective 15

Income Replacement 15

Is This the First Nail in the Coffin of Defined Contribution? 16

“Hold on a Second . . . ” 17

PART ONE The Dynamics of the Retirement Plan

CHAPTER 2 More than You Ever Wanted to Know about Life Expectancy 21

What Is “Life Expectancy”? 21

How Life Expectancy Has Changed 22

But an Individual’s Life Span Is Uncertain 23

Longevity Distributions: Let’s Take a Look 26

What Does This Mean? 29

And Will Longevity Improve Even More? 30

CHAPTER 3 Retirement Is Expensive 31

The Goal Is a Targeted Level of Income Replacement 32

The Fundamental Pension Equation and the Defined

Benefit System 33

A Simple Model of Retirement Plan Accumulation and Decumulation 34

Base Case Results 34

When to Start Saving 37

The Base Case May Not Be a Reliable Guide 38

How to Act in the Face of Uncertainty 39

Appendix: Further Analysis of the Uncertainty Associated with Investment Returns 41

CHAPTER 4 Investment Returns Are All-Important 43

The 10/30/60 Rule 44

Games at a Virtual Casino 46

Investment Analogs 48

Historical Return Patterns 49

What Are the Lessons? 52

What Follows? 54

How Much Investment Risk Can You Tolerate? 54

CHAPTER 5 Sustainable Spending 57

Lifetime Annuities 57

Simulations 58

Appendix: The Multiple 61

PART TWO Opportunities in the Accumulation Phase

CHAPTER 6 Save More 65

Employers with No Plan 65

Employees Who Do Not Enroll 67

Employees Who Start Saving Too Late 69

Employees with Low Savings Rates 70

Employees with Gaps in Continuous Participation 72

CHAPTER 7 Limit Leakage 75

Cashing Out 75

Loans 76

Hardship Withdrawals 77

CHAPTER 8 Invest Better 81

Evidence of Waste 81

The Importance of a Good Default Option 83

The “Target Date” Solution 84

And for the Investment Experts? 89

CHAPTER 9 Reduce Fees 91

The Impact of Fees 91

Fees for What? 92

Looking for Fee Leakage 92

Fee-Sharing Arrangements 93

Institutional versus Retail Fees 94

Active Management 95

Record-Keeping Fees 97

PART THREE We Need the Right Sort of Education

CHAPTER 10 Why the Waste? Because We’re Only Human 101

Overconfidence in Retirement Planning 101

Behavioral Finance 102

Low Participation and Savings Rates 103

Poor Investment Results 106

What to Do? 108

CHAPTER 11 Financial Education 109

Facts that Surprised Us 109

Enthusiastic Initiatives 110

What Exactly Can Be Taught? 112

Why Hasn’t This Already Been Taught? 115

A Literate Default System 115

A Final Anecdote 116

PART FOUR Other Ways of Running Defined Contribution Plans

CHAPTER 12 Case Study—Australia 119

Some Features of the Australian Defined

Contribution System 120

Consequences for Coverage 121

Consequences for Adequacy 122

Consequences for Employer Attitudes 123

Lessons for the United States 124

Consequences for Investment Choices 125

CHAPTER 13 Three Defined Contribution Plan Models 127

The Bank Savings Model 127

The Fund Supermarket Model 129

The Retirement Income Model 129

An Example of a Participant Statement in the

Retirement Income Model 130

CHAPTER 14 Collective Defined Contribution 133

The Principles 133

Broader Applications by the Dutch and Canadians 135

There’s More than One Way to Skin a Cat 137

PART FIVE The Perspective of the Individual in Decumulation

CHAPTER 15 The First Dial: Your Personal Spending Policy 141

Step One: How to Keep Score—The Current Position 142

Step Two: What about the Future? 144

Step Three: The Projected Outflow—The First Attempt to Quantify Your Spending Plan 145

Step Four: How Long Will Your Assets Sustain Your Spending Plan? 147

Checkpoint: Is There a Gap to Be Bridged? 148

Next Up 150

CHAPTER 16 The Second Dial: Your Longevity Protection Policy 151

How an Immediate Annuity Works 151

The Benefit of Buying a Lifetime Annuity 153

Should Everyone Buy an Immediate Annuity? 154

Reasons Why Some People Don’t Like to Buy

Immediate Annuities 156

Fortunately . . . 157

Appendix: More on Annuity-Equivalent Wealth 157

CHAPTER 17 The Third Dial: Investment Policy 159

A Reminder of Our Goals and Our Choices 159

A Framework 160

Taking Owner-Occupied Real Estate

into Account 161

Many Rules of Thumb Are Just Plain Wrong 163

Four Wealth Zones 164

How Your Wealth Zone Determines

Your Choices 166

Bequests 169

CHAPTER 18 Product Innovation with Decumulation in Mind 173

Variations on the Lifetime Annuity 173

Longevity Protection Plus Long-Term

Care Insurance 174

Guaranteed Minimum Withdrawal Benefits 175

The Longevity Pool 177

Advanced Life Deferred Annuities 177

Pure Decumulation Products 178

Which Type of Product Is Best? 179

PART SIX The Plan Sponsor’s Role

CHAPTER 19 Defined Contribution Plan Governance 183

The Purpose of Defined Contribution Plan Governance 183

Risk Management 184

A Defined Contribution Plan’s Purpose and Objectives 185

Fiduciary Duty 186

What Should a Prudent Expert Know—And When? 189

New Choices Based on New Knowledge 189

In Summary 190

CHAPTER 20 Defined Contribution Plan Effectiveness 191

Participation Rate 193

Participation Delay 193

Employee Savings Rate 194

Employer Contribution Rate 195

Match Maximization 195

Participant Net Investment Return 196

Hardship Withdrawal Usage 198

Loans as Distributions 199

Early Withdrawals 200

Conclusion 200

CHAPTER 21 The Defined Contribution Plan Sponsor’s Role in Decumulation 201

Providing Education 202

Providing Access to Financial Products: In-Plan or

Out-of-Plan 203

Design Features 204

Product Features 205

Simplicity 206

Parting Thought 206

Notes 207

About the Authors 223

Index 225

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Don Ezra is a widely published author. He has won a Graham and Dodd Award from the Financial Analysts Journal, the Roger Murray Prize from the Q Group in the United States, and the Lillywhite Award of the Employee Benefit Research Institute "for extraordinary life contributions to Americans' economic security."

Bob Collie has been working with defined benefit and defined contribution plans in the United Kingdom and United States for more than twenty years, playing at different times the role of actuary, investment consultant, and strategist.

Matthew X. Smith has been involved with the design, implemen-tation, administration, consultation to, and asset management of defined contribution plans for over twenty-five years. He has also written and spoken widely on defined contribution topics.

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