The birth of modern defined contribution (DC) plans can be traced back to the mid-1970s in the U.S., largely as a response to the passage of ERISA in 1974. By the late 1980s — following more legislation and regulations that further increased the operational risks and costs of sponsoring defined benefit (DB) plans — DC plans truly took off. Although initially intended to top off retirees’ income from traditional pensions, DC plans were soon replacing DB schemes entirely. Account-based DB plans, such as cash balance and other so-called hybrid plans, emerged as another alternative, and by the turn of the century traditional DB plans were in full retreat.
In the U.K., DC plans were also considered supplemental at first and were typically known as additional voluntary contributions. From the mid to late 1990s, U.K. companies started closing DB plans, ushering most new hires into a DC-only environment. More recently, large numbers of employers have frozen their DB plans, leaving far fewer participants still accruing benefits.
While the shift from DB to DC plans got off to a later start in the U.K., the changeover was faster, as hybrid plans were not embraced as a substitute for traditional DB plans in the U.K. like they were in the U.S. By 2002, the percentage of large U.K. employers offering only a DC plan to newly hired salaried employees surpassed that of their U.S. counterparts (Figure 1). Today, the U.K.’s private-sector retirement landscape is almost entirely DC only.
Figure 1. Prevalence of DC-only environment for salaried new hires, 1998 – 2016
Click to enlarge
Sources: Multiple years of the Willis Towers Watson U.K. Pension Plan Design Survey, the FTSE DC Survey and the Fortune 100 Survey. The Fortune 100 is the list of the 100 largest companies in the U.S. by gross revenue, and the FTSE 100 is an index composed of the 100 largest companies listed on the London Stock Exchange.
While all Fortune 100 companies offer a DC plan to new hires and have done so for the past few decades, slightly less than one-third offer a DC plan to supplement their main DB (mainly hybrid) plan, while more than two-thirds offer only a DC plan to newly hired salaried workers (Figure 2).1
Retirement plan types
When an employer offers only a DC plan to new hires, we classify it as “DC only.” An employer that offers a traditional DB plan and a DC plan is classified as “traditional DB plus DC,” and if the DB plan is a hybrid, the classification is “hybrid DB plus DC.”
Figure 2. Retirement plan types provided to newly hired salaried employees*
*Numbers may not sum to 100% due to rounding.
Sources: Willis Towers Watson 2015 FTSE DC Survey and the 2016 Fortune 100 Survey
Only 3% of Fortune 100 companies in 2016 and 1% of the FTSE 100 in 2015 were still offering traditional DB plans to newly hired salaried employees.
Contribution structures within DC plans
There are many similarities in the ways the largest companies in the U.S. and U.K. deliver retirement benefits and encourage employees to save.
- On both sides of the Atlantic, most DC plans include behavioral incentives that reward those who save more for retirement, such as by matching the employee’s contribution up to a certain percentage of pay. Most FTSE 100 and Fortune 100 companies offer matching contributions on a 1:1 basis, meaning the employer matches each extra pound or dollar an employee contributes.
- DC plans in both countries commonly use automatic features to boost enrollment and retirement savings. In the U.K., automatic enrollment is mandatory and hence more prevalent than it is in the U.S., where it is popular but optional. On the other hand, automatic increases to plan contributions are both more common and increasingly popular among American companies.
- In both countries, rate designs are typically uniform across all employees: Less than one quarter of Fortune 100 and FTSE 100 companies vary contributions by workforce segment.
To encourage employees to save for retirement, employers in both countries rely extensively on matching contribution structures. Under these arrangements, employers increase their plan contributions as employees increase theirs. In fact, 95% of Fortune 100 and 75% of FTSE 100 companies offer DC plans with a matching feature. In the U.K., the use of matching contribution structures has almost doubled since 2004, while their use has always been a staple of DC plans in the U.S.
Matching contributions are often combined with nonmatching or noncontributory contributions, meaning the employer contributes some baseline amount even for noncontributing employees. In the U.S., the use of such designs has doubled since 2006, reaching 42% of Fortune 100 companies, with the arrangement typically put in place after the company freezes or closes a DB plan. Only 29% of DC plans in the U.K. feature nonmatching contributions.
Matching formulas are provided through a single-tier or multi-tier formula. In a single-tier structure, an employer might contribute one pound or dollar for each pound or dollar a worker contributes, up to a certain percentage of pay. In a multi-tier formula, employer contributions vary by the level of employee contributions. For example, an employer might match the worker’s contribution one-to-one up to 6% of pay, and then contribute 50 pence/cents for every pound/dollar contributed by the worker up to another 4% of pay.
Employers in both countries generally offer matching contributions through a single-tier formula, although roughly one in four Fortune 100 companies uses a multi-tier formula. One-third of U.S. companies using a single-tier formula offer matching contributions on less than a one-to-one basis, while two-thirds match at 100% or more. In the U.K., almost all FTSE 100 employers match at least 1:1 and about one in three offers a higher match rate. As a result, while the average matching employer contribution is around £1.3 for every £1 employee contribution in the U.K., the average is roughly dollar-for-dollar in the U.S.
The use of “discretionary” contributions constitutes a significant difference between the two countries. These contributions may be contingent on company performance and can be suspended at any time, as we saw during the 2009 financial crisis.2 Discretionary contributions are far more widespread in the U.S. than in the U.K., where they are extremely rare. In fact, 40% of Fortune 100 companies that provide nonmatching contributions have made them discretionary, although matching contributions are rarely discretionary.
In response to concerns about declining plan participation and the government’s desire to shift the burden of retirement provision away from the state, the U.K. now requires employers to automatically enroll eligible employees in their retirement plan, albeit with an option to opt out. This requirement will be fully phased in during 2017, although at the time of our 2015 survey, automatic enrollment was already largely universal among FTSE 100 companies.
By contrast, automatic enrollment in the U.S. is optional but pervasive nonetheless; indeed, the apparent success of auto-enrollment in boosting U.S. participation rates was one motivation for the U.K. legislation. More than half of Fortune 100 companies automatically enroll workers into their DC plans and provide for automatic deferrals. The most common default rate for automatic deferrals is 3% of pay among the Fortune 100 — typically ranging between 2% and 10% of pay — and 2% among the FTSE 100.
To ensure that employees contribute more over time, 58% of Fortune 100 companies with auto-enrollment also use auto-escalation, which increases employee deferrals, typically annually, unless the employee opts out. In the U.K., while phased increases in statutory minimum contribution rates are currently planned (via auto-enrollment legislation), auto-escalation is optional and employers rarely offer it, although interest seems to be growing.
Increasingly uniform contribution rates
Another important element of contribution structures is whether employers contribute at the same rate for all employees. For example, an employer might vary contribution rates by employee age, service and salary or job grade. Fewer than one in four Fortune 100 or FTSE 100 companies bases contributions on workforce segment.
Nonuniform contribution rates are more common in Fortune 100 companies that provide nonmatching contributions, and usually relate to age and years of service. Varying contributions based on salary could violate nondiscrimination rules in the U.S.
As DB plans were being closed in the U.K., age-related contribution structures were popular among a minority of employers (to replicate age-related accruals in DB plans), although their popularity has waned since then.
How do contribution rates compare in practice?
Figure 3 shows DC designs that are fairly common in the U.S. and U.K., and the numbers are consistent with the most prevalent contribution designs in Fortune 100 and FTSE 100 sponsored plans.
Figure 3. Illustration of a common DC plan — choice of contribution rates
Note: Contribution rates are from the most representative DC component of DC-only and hybrid plans. Rates are assumed to be uniform and employees do not opt out of auto-enrollment.
Sources: Willis Towers Watson 2015 FTSE DC Survey and 2016 Fortune 100 Survey
Among the Fortune 100, a common design is to automatically enroll employees into the plan at a 3% deferral rate and to match 100% of their additional contributions up to 6% of pay. This adds to a total maximum contribution of 12%: 6% from the employee and 6% from the employer.
Among the FTSE 100, a typical design would automatically enroll the worker at a 2% contribution rate, with the employer contributing 5%. Thus, at initial enrollment, the worker defaults into a total (employee plus employer) contribution rate of 7%. These rates are close to complying with the mandatory minimum contributions that will be introduced as part of automatic enrollment legislation in 2019 — a total of 8% with at least 3% of that contributed by the employer. Thereafter, the employer matches any additional employee contributions 1:1 up to a maximum 4% of pay, adding up to a maximum contribution of 6% from the employee and 9% from the employer (assuming the employee defers the amount required to receive the full match).
Understanding these differences
Based on average contributions to DC plans, the FTSE 100 companies are more generous than their Fortune 100 counterparts by 3.5% of pay (Figure 4). The primary difference is the generosity of employer contributions in the U.K., particularly employer core contributions, which include nonmatching contributions and matching contributions under auto-enrollment arrangements.
Figure 4. Average DC contribution rates
Notes: Assumes the worker defers the amount necessary to receive the maximum employer contribution. U.S. data calculated for a 35-year-old employee with five years of service and an annual salary of $50,000. U.S. – uniform refers to plans where contribution rates are the same for all employees. U.K. rates are based on characteristics of the largest group of employees. Employer core values represent nonmatching contributions and matching contributions under automatic enrollment. U.S. employee core values are the default deferrals under auto-enrollment arrangements.
Sources: Willis Towers Watson 2015 FTSE DC Survey and the 2016 Fortune 100 Survey
Recent auto-enrollment legislation in the U.K. mandates minimum contribution rates, which are quite low initially but increase over time. Many plan designs were already in compliance, but the new floor for contribution rates has increased costs for some U.K. employers.
In the U.S., on the other hand, matching contributions constitute the majority of contributions from employees and employers. The employee core values in Figure 4 represent employee deferrals that will be matched by employers in auto-enrollment arrangements. Employer core values reflect matches under auto-enrollment arrangements as well as employers’ nonmatching contributions. Nevertheless, average maximum employee contributions (up to the amount that triggers the maximum employer match) in both countries are remarkably similar — between 5% and 6%.
There are considerable differences between Fortune 100 companies that contribute at the same rate for all employees, and those that vary contributions by workforce segment. For the latter, the average total contribution is 2.3 percentage points higher, driven by more generous employer contributions.
Retirement plans are viewed as a standard part of the benefit package in both the U.S. and U.K., but health insurance makes up a substantial share of total remuneration in the U.S. This is not the case in the U.K., where the National Health Service provides comprehensive health care to everyone and employers only provide private insurance to top-up the government-provided health care. In Fortune 100 companies, benefit dollars must be shared between health care and retirement, and rapid medical cost inflation often crowds out the latter.3 Moreover, U.S. Social Security retirement benefits are typically more generous than the U.K.’s state pensions.4
A final consideration in comparing retirement plan contributions in the U.S. and the U.K. is the presence of a DB plan. Some U.S. companies contribute to both hybrid DB and DC plans, whereas DC-only is the norm in the U.K., so leaving out hybrid plans understates the generosity of Fortune 100 companies. The following section addresses the structure and effect of contributions to U.S. hybrid plans.
Hybrid DB plans and total retirement contributions
While hybrid plans never really took off in the U.K., about one quarter of Fortune 100 companies offered newly hired salaried workers both a hybrid plan (predominately cash balance) and a DC plan in 2015. Hybrid plans are funded entirely by employers’ contributions (pay credits) and do not typically require employee contributions. Unlike in a DC plan, hybrid plan sponsors shoulder the investment risk. In a typical cash balance plan, the worker’s account balance grows with interest rates that are not linked to the value of the plan’s investments.
Among Fortune 100 hybrid plan sponsors, pay credits range between 3% and 15%, with the average contribution rate roughly 5% for our benchmark employee, which suggests that sponsoring a hybrid plan almost doubles the employer’s total retirement contributions.
Adding hybrid DB pay credits to DC contributions from Fortune 100 companies raises total retirement contributions by 1.4% to an average 12.7% of pay (Figure 5), which is much closer to the average U.K. contribution (14.8%). Average retirement plan contributions from Fortune 100 companies that sponsor both DC plans and hybrid DB plans is 15.4% of pay — higher than average contributions from their U.K. counterparts.
Figure 5. Average total contribution rates of DC and hybrid plans in the U.S.
Note: U.S. data calculated based on a 35-year-old employee with five years of service and an annual salary of $50,000. The calculation assumes the worker defers the amount necessary to receive the maximum employer contribution.
Sources: Willis Towers Watson 2015 FTSE DC Survey and the 2016 Fortune 100 Survey
Investment and retirement options: managing choice
In the early days of the shift to DC-only plans, giving employees more flexibility and choice was viewed as empowering. Yet the multitude of choices proved debilitating for some employees, acting as a hindrance to decision making. More recently, there has been a recognition that limiting or streamlining choices can enable greater engagement, and companies are trying to simplify retirement decisions for their workers.
In providing a range of investment options to employees, employers face a challenge: providing sufficient investment options to satisfy a diverse workforce without overwhelming some workers with too many choices.
The earliest DC plans generally provided the widest range of investment options possible. Given more recent recognition on both sides of the Atlantic of the downside of such choice, plan defaults and the number or range of investments have become top areas of focus for governance of DC plans.5,6 All the same, some nine in 10 DC plans in Fortune 100 companies offer between 11 and 50 investment funds (Figure 6).
Figure 6. Number of investment options
Sources: Willis Towers Watson 2014 U.K. DC Pension Scheme Survey and the 2016 Fortune 100 Survey
The U.K. has come full circle in terms of investment choice, starting off with no or very limited choice, then offering a wide array of choices and now scaling back the number of available funds. This is particularly true in trust-based retirement plans, which typically offer between five and 15 funds to employees. By contrast, contract-based retirement plans (which are provided by insurers) offer even more options than U.S. plans: Over 60% of these plans offer more than 50 investment funds (none of the U.S. companies offers that many options).
One tool common to both countries for simplifying the choices for less sophisticated investors is the extensive use of default funds. In both the U.S. and U.K., these are typically life-cycle funds, which gradually shift allocations from riskier assets into bonds and other low-risk investments as the employee approaches retirement. Such an approach limits employees’ exposure to risk as their window for recovering losses closes.
Yet a closer look uncovers significant differences between the two countries. In the U.S., life-cycle strategies are generally implemented through target-date funds (TDFs), which reduce allocations to risky assets gradually over the employee’s life. For example, a fund might start with a 90% allocation to equities for a 25-year-old participant, then begin de-risking slowly when she reaches 45, attaining a 50% allocation to equities at around age 65 and arriving at 25% by 85.
Life-cycle funds in the U.K. share the same broad aim, but the de-risking period has traditionally been shorter and steeper. In the past, many funds would have been 100% invested in equities (or other growth assets) up to age 55, and then would shift entirely to bonds and cash over the next 10 years. This reflected historical restrictions on access to the funds at retirement, which ensured that most employees purchased an annuity. Plans typically then targeted an investment portfolio at retirement that “matched” the assets backing those annuities.
In 2015, the U.K. relaxed the restrictions on access to DC accounts at retirement, so retiring employees no longer have to buy an annuity, although roughly four in 10 U.K. plans still target annuities in the default scheme.7
In both countries, life-cycle funds follow a prescribed glide path to reduce investment risk, but this is handled mostly automatically in the U.K., while funding managers have more control over the glide path in the U.S.
Choices at retirement
The shift from DB to DC plans has given employees a wider array of options at retirement. In the U.S., the historical starting point has been employees drawing down on their DC retirement saving themselves: Only 11% of Fortune 100 companies offer an annuity in their DC plan. According to a survey of DC plan sponsors,8 the main reasons for not offering lifetime options are fiduciary risk, cost and unsatisfactory or untested market options. The shift away from lifetime income payments accompanied by the transition from DB plans to DC plans as the sole retirement vehicle has prompted the U.S. government to consider removing regulatory barriers to offering annuities under DC plans.
The U.K. seems headed in the other direction. Since April 2015, DC plan participants in the U.K. have had complete control over their retirement funds, and the number of employees purchasing annuities at retirement has fallen by around 75%.9 Nevertheless, around 80,000 U.K. retirees a year are still purchasing annuities with all or part of their DC retirement savings. It remains to be seen how these practices will evolve as alternative means of drawing on retirement assets emerge and, indeed, as DC plans mature and participants’ accumulations at retirement — now relatively modest in the U.K. — become much more substantial.
The communication challenge: engaging participants
In both the U.S. and U.K., employers believe most of their employees are neither planning wisely nor ready for retirement. Only one in 10 companies in both countries believes that their employees know how much they should save for retirement, and just 7% of British companies and 20% of American companies think their employees are comfortable making retirement investment decisions.10,11
With this in mind, eight in 10 companies in both countries expect to step up their efforts to educate employees on saving and investing for retirement within the next two to three years. Moreover, they plan to increase their focus on communication and employee engagement (Figure 7). While the focus — both current and planned — is stronger among U.K. companies, this may reflect an effort to bring their communication strategies more in line with those already being practiced by their U.S. counterparts.
Figure 7. Current and future focus of DC plans on communication and employee engagement
Sources: Willis Towers Watson 2016 U.S. Retirement Plan Governance Survey and 2015 U.K. The Future of DC Survey
Most plan sponsors rely heavily on standard communication methods, such as newsletters, online education and one-on-one or group meetings (Figure 8). New, more technology-intense forms of communication, such as gamification, are not yet widespread. In general, U.S. companies tend to use communication tools more broadly, especially those relating to email and meetings with plan participants. The use of mobile applications is becoming more common in the U.S. but is still limited in the U.K.
Figure 8. Prevalence of methods of communicating with employees
Sources: Willis Towers Watson, 2014 U.S. Defined Contribution Plan Sponsor Survey, and 2015 U.K. Retirement Adequacy: The Employer Perspective
In our increasingly DC world, both the U.S. and U.K. seem headed for a common approach: automatic enrollment into a matching contribution structure with a default life-cycle investment fund and flexibility over how participants manage those funds after retirement. Over the last decade in both countries, newly hired salaried workers have been made increasingly responsible for their own retirement savings. Meanwhile, DC plan sponsors are providing guidance in the form of behavioral incentives, such as matches to encourage employees to save, automatic enrollment and default funds for those who might otherwise feel overwhelmed by too many investment choices. Today’s revamped retirement structure also provides guardrails in the form of life-cycle investment funds to minimize timing risks for default investors.
Nevertheless, not enough employees in either the U.S. or U.K. are actively engaged in retirement planning or contribute enough to retire when they would like. In fact, 28% of plan participants in the U.S. and 21% in the U.K. expect to work until 70 or even later.12 Given current expectations, almost two in five U.S. companies view retirement readiness as a risk today,13 and one in four U.K. fiduciaries of pension schemes states that the main objective of sponsoring employers is to provide an adequate standard of living in retirement.14
But in a working world where pay growth is stagnant and many people struggle with significant loans or debt, employers are increasingly interested in giving employees more say over how their benefit dollars are allocated, shifting resources toward financial well-being more broadly.
Such a strategic realignment of benefits might arguably deliver better immediate value to employees, but at the cost of diverting money from retirement saving. Can employers help their employees prepare for retirement while also achieving broader (and more immediate) financial well-being? This could well be the key factor in shaping employers’ retirement provision over the coming decade.
About the surveys
Information for the U.S. is primarily based on Fortune 100 companies’ accounting reports attached to Forms 5500 (annual reports) submitted to the Department of Labor for their largest DC plan covering salaried employees for the 2015 plan year (the latest available).
The U.K. data cover 95 of the FTSE 100 companies. The analysis excludes DC schemes that are not the main arrangement for new entrants, plans sponsored by small subsidiary businesses and designated stakeholder schemes with no employer contributions. Most FTSE 100 companies also completed our questionnaire and some supplied their plan booklets, while information for others was obtained from within our own organization or using information available in the wider pensions domain.