Retirement benefits play an important role in attracting and retaining top talent. But to keep steadily rising benefit costs in check, employers are shifting the risk and responsibility of financing retirement to workers by moving from defined benefit (DB) to defined contribution (DC) and hybrid retirement plans. The hurdle organizations face is high: They need to control plan costs while offering retirement benefits as part of a total rewards program that attracts and retains the right people.
Four senior Towers Watson retirement consultants — Mark Byrne, Myrna Chao (moderator), Robyn Credico and Jennifer DeMeo — discussed how companies need to treat retirement benefit plans not as isolated benefits but as components of a sustainable total rewards program.
Chao: Let’s start by talking about the shift from DB to DC retirement plans. What’s the business rationale for the shift, and what are the implications for total rewards?
DeMeo: The Towers Watson Pensions in Transition study — our survey of plan sponsors — found that many employers make the decision to offer a DC plan to new hires, instead of a DB plan, in order to reduce costs and future cost volatility. The DB-to-DC shift presents companies with a major challenge: controlling costs effectively while still delivering benefits their employees can rely on after they retire. But the shift also gives employers an excellent opportunity to put the concept of total rewards to work for their organization.
Total rewards is the full array of programs — monetary and nonmonetary — that an employer provides to support, enable, engage and focus the employees it needs to be successful. Benefit programs are one piece of the total rewards puzzle. When companies make significant changes to their retirement benefit programs, they should consider the changes in a total rewards context. By looking at the entire package, employers can see whether it makes sense to make adjustments in other reward elements.
For instance, when companies reduce the richness of their DB programs, they might be able to enrich other programs that cost the employer less but that employees value more. This not only helps employers meet workers’ needs but also provides better value for the business from both a financial and retention perspective.
Understanding a company’s financial objectives and reward philosophy, as well as employee preferences, can help the organization allocate limited resources optimally among the various reward elements.
Byrne: When making such changes, employers should be aware of the complexities and alternatives. Moving to a DC arrangement shifts future risk to the employees; it doesn’t eliminate the risk. When companies terminate or freeze their DB pension plan and move to a DC plan, they haven’t addressed pension plan volatility or eliminated risk for the coming decades. There are much more efficient approaches to reducing plan volatility than through plan design. A well-designed cash balance plan with an aligned investment strategy can reduce interest rate risk and investment risk.
Retention, Cost Control and the Role of the Employee
Chao: How can employers that are terminating or freezing their DB plans avoid dulling their recruitment edge?
Credico: Benefit professionals at most companies are less concerned about going from a DB to a DC plan and more worried about how they can help employees save for retirement. If employers offer plan participants a matching contribution that’s similar to what others in the industry provide, they can at least maintain competitive parity. The downside is that DC plans help recruit workers, but most do little to help retain them.
DeMeo: Yes, it’s important for an organization to understand what will attract and retain the employees it needs and to be less concerned about overall trends, which won’t meet the needs of every organization. Companies in industries where DC plans predominate will often offer a DC plan to attract employees. But organizations in sectors where DB plans are more common understand that a DC plan might be less appealing to the employees they need and want.
Credico: Let’s not forget the bottom line: To save money, companies are shifting the burden of financial responsibility from the employer to the employee. But in the long run, if employees who are offered DC plans don’t make the right decisions, the employer could pay the price in the form of employees delaying retirement because they can’t afford to retire. These employees tend to be more expensive, and their productivity can flag. Also, they can create bottlenecks for younger employees’ career enhancement. While such things might not be line items on a budget, they can have major repercussions on business performance.
Byrne: Yes, when workers believe they can’t afford to retire, employers need to help them understand how to optimize the available portfolio of savings and investment vehicles.
For example, an employee with a standard 401(k), a Roth 401(k) and a health savings account needs to know how to optimally distribute his or her savings among these different vehicles. The employer needs to educate workers, and spur the right financial habits and behavioral changes.
Mechanisms that help accomplish this include 401(k) plans with DB-like automatic features — automatic enrollment, contribution and escalation of contribution amounts — that don’t require a matching contribution.
More Than a Quick Fix
Chao: When employers transition groups of workers from DB to DC plans, they’re segmenting the workforce. Because employees at different stages of their work lives — early-career and midcareer workers, those nearing retirement, and those past retirement age who can’t afford to retire — have different needs, employers need to use various methods for attraction and retention. How should employers segment their workforces with these things in mind?
DeMeo: Let’s talk about grandfathering, which gets to the heart of the issue. Grandfathered provisions allow employees nearing retirement age to retain a DB plan. These provisions are often predicated on the assumption that young and short-service employees value a DB plan less than do older and longer-service employees. But our recent Retirement Attitudes Survey found that DB programs have a much broader appeal among many workforce segments today than they did in the past. Perhaps as a result of the economic downturn, more employees of all ages and career phases value stability today than ever — you can’t always rely on the old assumptions.
Byrne: To retain senior-level employees, many companies grandfather them into the DB plan. That’s a form of segmentation — but is it a good practice? In 10 years or so, perhaps the more junior employees who have only DC plans will think about leaving the company for greener pastures.
The majority of employees still depend on their company-sponsored retirement programs for support after they retire. But some retirement programs don’t do what they’re supposed to do: enable workers to retire “on time” and then live comfortably. Employers that offer only frugal DC plans today could have serious retention issues down the road.
Credico: I have more than one client with an inordinate number of workers — including young people — who picked the DB plan because they see it as more secure. But employers that have closed their DB plans must help employees to better understand their personal retirement needs — and to save more, so they’ll be able to meet those needs.
The good news is that a recent Towers Watson survey found that a vast majority of employers want to support a meaningful retirement for their employees. The bad news is that most employers still design their DC programs based on budget and market competitiveness — which might not provide workers with adequate resources for retirement unless they save on their own.
DeMeo: Using DC plan features, such as auto-enrollment and auto-escalation — along with employer communication and assistance with financial planning — an employer can help employees adequately save for retirement.
Credico: But to prompt workers to save adequately, the automatic enrollment and automatic increases must be implemented properly. For example, auto-enrolling individuals at a low percentage of pay won’t get them ready for retirement. Effective automatic designs can be expensive, and so employers need to think creatively about their retirement plan designs to reward those who stay with the company. As an alternative to the automatic features, employers can think about other elements, such as a richer match or discretionary contributions. Your investment solutions must also be efficient enough to deliver solid benefits.
Here’s an example of a creative approach: One client that had automatic enrollment at 2% of salary also provided a discretionary contribution of 1%. Later, a new head of HR decided to provide an additional reward to longer-service employees who opted to participate in the DC plan — in other words, those who actively demonstrated a desire to save. The company eliminated both automatic enrollment and the accompanying 1% discretionary contribution and used the savings to offer a very rich matching contribution that rewarded employees with long tenure.
Chao: This is a tough issue. Today, many organizations claim they’re socially responsible. But when employees lack the resources to retire, the employer faces a significant credibility gap. These employers need to examine their DC plans, as well as their employees’ savings rates and investment behaviors, to get a firm handle on whether they can actually facilitate meaningful retirement for their people.
Fostering a Habit of Saving
Chao: I once ran a focus group of service center employees, many of whom said, “Don’t give me a 3% pay increase. I would just spend it, so I’d rather get the 3% added to my retirement plan.” Is it feasible to compel employees to trade part of their present-day compensation for future benefits?
DeMeo: Yes, it’s feasible. I worked with a client that considered replacing the profit-sharing feature in its DC plan with an immediate cash bonus. Through employee surveys, we discovered that employees preferred the profit-sharing contribution because it bolstered their retirement savings.
Credico: Most employees and employers alike prefer a DC savings mechanism over the cash contribution method. Because the employer’s contribution is money that workers typically don’t receive in their paycheck, employees don’t mind waiting for it. And employers have capitalized on this by providing more toward employees’ retirement in lieu of giving small raises.
Byrne: One caveat: I’ve seen that people often need the money right away, and they aren’t willing to make that long-term trade-off.
DB Plans as DC
Chao: I’m wondering how the shift from DB to DC plans affects executive compensation and vice versa, particularly in high-reward industries, such as financial services. From a total rewards perspective, how do the latest changes in incentive compensation affect retirement benefits?
Byrne: In essence, a DB pension plan is a DC vehicle — a critical part of an executive compensation package, and a good way to attract and retain workers via extended vesting. None of my clients have made the DB-to-DC shift for their executives, though other companies have done so. For most organizations, eliminating a DB plan makes it more difficult to attract senior executives. As for retention, even a 10% or 15% DC contribution isn’t perceived by executive-level employees as being as valuable as a DB plan.
Chao: Also, because of today’s increased scrutiny on compensation, we’re seeing an unintended effect: Numerous employers have essentially eliminated the concepts of normal retirement age and early retirement. As a result, it can be challenging to get an executive to retire at a particular age. The paradox is that it’s hard to offer the right incentives that encourage people to stay, to leave or to retire when you want them to.
DeMeo: I’m working with an employer that has moved to DC plans that offer no incentives for an employee to stay past a certain age. Not surprisingly, they’re grappling with how to encourage high-value executives to stay.
Byrne: For some employers, that’s the right decision. They simply don’t want the pension plan to be the primary motivation for a person to stay or leave. They want the organization and the career opportunities to be the things that attract and retain talent.
Ready or Not
Chao: Are clients concerned about whether the retirement plans they offer will make sense for their workforce five to 10 years from now?
Credico: Yes, clients are concerned. In our recent DC survey, a number of respondents said their employees expect to defer retirement for several years. While there isn’t too much that can be done for those close to retirement, employers are looking at how changes in benefit design, and employee utilization of benefit programs, will affect workers who are five or more years away from retirement.
Byrne: There came a time when the behemoths of the auto and steel industries had no choice but to restructure their retirement benefits. The airline industry inevitably had to restructure theirs as well. And the economic downturn has expedited countless companies’ move to DC plans. It’s best for employers to address these issues now and consider them carefully — before they’re forced into taking action.