A decade after the Pension Protection Act (PPA) of 2006 ushered in an era of reform for the U.S. retirement system, defined contribution plans are still falling short in promoting savings and offering investments that manage risks and provide retirement income, according to a new study by Northern Trust Asset Management.

The Path Forward: Defined Contribution Plans Can Achieve More, released today, tallies the successes of the PPA and proposes solutions to improve the performance of defined contribution (DC) plans, based on surveys of 1,000 DC plan participants and more than 100 DC plan sponsors, as well as interviews with a diverse range of industry experts.

“Despite many advances made since the passage of the Pension Protection Act, the retirement security of millions of Americans remains in question and the ideals at the heart of the PPA have only been partially realized,” said Sabrina Bailey, global head of Retirement Solutions at Northern Trust Asset Management. “The sixth edition of our Path Forward research series identifies specific actions plan sponsors can take to harness the power of the PPA and guide participants toward a secure and successful retirement.”

Improve implementation of automatic features

The PPA was the catalyst for DC plans to include elements such as automatic enrollment of employees into the plan, and automatic escalation of savings over time. Industry leaders interviewed for the Path Forward said these automatic features have helped combat participant inertia, a view supported by the plan sponsor and participant surveys.

Asked to identify the single biggest benefit of the PPA, the response cited the most by plan sponsors was increased plan participation as a result of auto enrollment. Similarly, participants indicated the ability to save painlessly through automatic deductions is the 401(k) feature they value most.

Despite the benefits offered by auto enrollment, Northern Trust’s survey shows that plan sponsors could challenge participants to save more:

  • While a majority (52 percent) of plan sponsors auto enroll new hires, just 32 percent implement auto escalation to increase participant contributions.
  • Nearly two-thirds (63 percent) of participants think they could contribute 10 percent or more of their income to retirement savings, but about the same percentage said their plan’s deferral rate was below 10 percent. Additionally, 65 percent said they wish they could go back and contribute a higher proportion of their salary to their 401(k) plan.

“The benefit of using both auto features in tandem is clear,” said Gaobo Pang, Ph.D., head of investor analytics for Retirement Solutions at Northern Trust Asset Management. “Among plan sponsors using auto enrollment and/or auto escalation, 64 percent think that participants using these features are better prepared for retirement.”

Understand and embrace risk in default options

The PPA enables plan sponsors to determine the default investment for their participants. Of auto enrolled participants, 72 percent keep their assets in the default option, demonstrating that the plan sponsor’s choice can have a powerful impact on participant outcomes.

Risk is a key factor in the selection of the default investment. While both plan participants (53 percent) and plan sponsors (46 percent) cited market risk as a key concern, they also mention a variety of other risks, such as inflation, longevity and concentration risk. In fact, 79 percent of plan participants are concerned about taking the right type of risk at the right time.

Over three-quarters of plan sponsors (79 percent) cite market volatility as a key risk for participants over the next five years, and 74 percent say inflation is another serious risk that will continue in the next five years.

“Risks evolve over time, so it is crucial that plan sponsors select a default investment option that can help plan participants appropriately deal with a variety of risks,” said Susan Czochara, managing director of Retirement Solutions at Northern Trust Asset Management. “By constructing a robust default option, such as a target date fund that adjusts in line with investment goals, sponsors can help participants manage risk exposures.”

Address retirement income needs

Industry leaders interviewed for the Path Forward said one major shortcoming of the PPA is a lack of provision for retirement income. Plan sponsors and participants agree this is a crucial issue:

  • 84 percent of participants surveyed are concerned about outliving their resources, and 84 percent of plan sponsors cited longevity risk – the risk that participants will outlive their assets – as a serious risk facing participants in the future.
  • 86 percent of plan sponsors and 87 percent of plan participants think it is important for a 401(k) plan to include investment options specifically designed for retirees.

“Although default options work well for most participants during the accumulation phase, people’s needs, circumstances and priorities tend to be very different when they retire,” said Czochara. “In designing a menu of options, plan sponsors need to consider three primary concerns – efficiency, safety and flexibility – to address a variety of retirement income needs.”

The Path Forward: Defined Contribution Plans Can Achieve More is the sixth edition of Northern Trust Asset Management’s research series on the future of DC plans. Previous installments surveyed plan sponsors and consultants on the attributes of an ideal defined contribution plan structure, the challenges of engaging younger employees and the potential for defined contribution plans to adopt best practices developed by defined benefit plans and other institutional investors.

“The retirement crisis the PPA sought to address 10 years ago still exists today, but our research highlights some of the steps that plan sponsors can take now to help participants save and invest more effectively,” Bailey said. “Participants are looking to plan sponsors to guide them with tools including auto features, default investments that address a range of risks and retirement income options to meet a variety of needs. Effective plan design and implementation has never been more important.”

Northern Trust manages more than $118 billion in assets for U.S. defined contribution plans and provides custody and administrative services to more than $297 billion in DC assets, as of June 30, 2016. Retirement Solutions takes a consultative approach to addressing the needs of plan sponsors and participants while offering a suite of solutions – including an inflation-sensitive asset fund and target date funds – aimed at improving retirement outcomes. More information can be found at www.northerntrust.com/dcsolutions.

Northern Trust Asset Management is a leading global asset management firm serving institutional and individual investors in 29 countries, with $906 billion in assets under management as of June 30, 2016. Northern Trust Asset Management’s robust investment capabilities span all markets and asset classes, from passive and risk-factor to fundamental active and multi-manager strategies, delivered in multiple vehicles. For more information, please visit our website or follow us on Twitter @NTInvest.

Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, 50 South Capital Advisors, LLC, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc. and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

About Northern Trust

Northern Trust Corporation (Nasdaq: NTRS) is a leading provider of wealth management, asset servicing, asset management and banking to corporations, institutions, and affluent families and individuals. Founded in Chicago in 1889, Northern Trust has offices in the United States in 19 states and Washington, D.C., and 22 international locations in Canada, Europe, the Middle East and the Asia-Pacific region. As of June 30, 2016, Northern Trust had assets under custody of US$6.4 trillion, and assets under management of US$906 billion. For more than 125 years, Northern Trust has earned distinction as an industry leader for exceptional service, financial expertise, integrity and innovation. Visit northerntrust.com or follow us on Twitter @NorthernTrust.

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