The Observer

ARTICLES OF INTEREST

Get engaged! Review your retirement plan design

by Mazen Shakeel, Sun Life Financial

Retirement industry changes occur frequently – is your plan keeping pace? Don’t let inertia stop you from reviewing and optimizing your workplace savings plan design
 
Plan member engagement is often a prerequisite for retirement savings success. But there’s another “engagement” statistic that’s too often overlooked: the engagement of the plan sponsor in regularly reviewing their plan design. Adapting a plan’s design to reflect changing circumstances can have a profound impact on both plan member engagement and savings success.
 
Overcoming inertia – acting on change

While plan member inertia continues to be a challenge for plan sponsors, the group retirement industry has introduced several initiatives to combat this and increase engagement. These include automatic enrolment (where legislation permits), automatic investing – which has contributed to the rapid growth of target date funds, and simplified enrolment that uses smart defaults to enroll an employee in their workplace plan.
 
And there are more advancements to come. The questions for a plan sponsor are simple ones:

 
  1. Have you reviewed the advancements available? 
  2. Have you considered other economic, social and demographic challenges (such as low interests, or increasing longevity) to determine whether your current plan administration and design can be improved?
 
The Critical Role of Plan Design

As an industry, we focus extensively on increasing plan member engagement, but engagement is only one of four key drivers that contribute to a successful retirement plan. The plan sponsor has direct control over the other three:

 
  1. Plan design: Design decisions range from participation rules, to the enrolment process, to contribution rules and rates. All of these decisions can contribute to a plan’s success 
  2. Plan management: This includes governance and oversight to ensure that the plan complies with guidelines and legislation. 
  3. Plan investments: An investment lineup with choice, quality managers, and the option of choosing a pre-built one-stop solution is essential to plan health and plan member success.
 
 

Is the plan design piece of the puzzle reviewed often enough by plan sponsors? Here’s a telling statistic. Sun Life administers nearly 5,000 plans, representing more than 1.3 million plan members. For every five plans that undergo an amendment each year, four make a change to the investment lineup while just one makes a design-related change (such as changing the waiting period, adding a new savings option such as a TFSA, or changing the contribution formula).
 
Here are two scenarios as an example.

 
  • Scenario 1 – higher investment returns: a change to a plan sponsor’s investment lineup results in employee investment returns being 1% higher than the base scenario each year.
  • Scenario 2 – increase in annual contributions: the plan sponsor makes a design change that results in employees increasing their annual contributions by 1%, and thereby attracting an additional 1% employer match.
 
The chart below compares the benefits of the two scenarios. It would take 35 years for the 1% investment return in scenario 1 to equal the benefit of the increased contributions in scenario 2. In other words, a plan design that increases the employee savings rate by 1% and attracts an employer match of 1% is roughly equivalent to receiving an extra 1% investment return, but it would take almost the full length of an employee’s career (35 years) to get there.
 


Assumptions:
  • Baseline assumes a total contribution rate of 10% (member and sponsor combined), and a net rate of return of 4.75%
  • Scenario 1 assumes a total contribution rate of 10% (member and sponsor combined), and a net rate of return of 5.75%
  • Scenario 2 a total contribution rate of 12% (member and sponsor combined), and a net rate of return of 4.75%
  • Salary assumed to increase 3% annually, $0 starting balance and contributions made monthly
 
Look beyond investment returns: The Importance of “Money in”

“Money in” is still the greatest determinant of “money out” in retirement. For this reason, plan design features such as the definition of earnings for contribution purposes, the level of required contributions, and the degree of company matching are considerations that can have a significant impact on a plan member’s ultimate retirement income.
 
One of the key issues in today’s environment is that more “money in” is needed to get the same results as just a generation ago. When the RRSP contribution limit was first set at 18%, the rationale was that 18% contributed and invested at that time for 35 years would produce an income replacement of about 70% at retirement (similar to an employee with 35 years of credited service participating in a two percent final average earnings defined benefit pension plan).
 
In the current environment (lower interest rates, longer life spans), the 18% total contribution rate limit falls short. Assuming an average life expectancy in retirement of 21 years, the contribution limit should really be closer to 22% today. The issue is that plan designs haven’t changed to encourage higher contributions, and employees haven’t increased their savings levels materially to keep pace.
 
It’s prudent from a planning perspective to assume that future advances in medicine, and our growing knowledge of the causes of aging, will lead to future increases in life expectancies. And living longer increases the risk of outliving our savings, unless we plan for it in advance.  For example, a four-year improvement in life expectancy can reduce a 70% income replacement rate by approximately 10%.
 
A focus on lump sum wealth accumulation – and not an end goal of retirement income – may have created a false sense of security for plan members. Simply put, they may not appreciate that increases in life expectancy, or declining or low interest rates, can offset the impact of moderate investment performance.
 
For example, if interest rates are 3% at retirement instead of 5%, a retiree would need 20% more savings to get the same retirement income if they were purchasing an annuity. For this reason, conversations with plan members would be more productive and meaningful if they steered away from account balance goals to consider what those assets could produce in terms of retirement income. Plan members could then adjust their ongoing contributions accordingly.
 
Four Action Steps you can take to overcome inertia

Your investment in a workplace retirement savings plan is significant, and it’s important to ensure you’re getting maximum value for you and your employees. The issue is that inertia can set in, and years can slide by as other projects fill up the human resources calendar.
 
It’s time to give your workplace plan the attention it deserves. Here are four steps you can take to ensure your workplace retirement savings plan achieves its goals.

 
1) Define a set of objectives for your plan: It’s impossible to achieve plan goals if those goals aren’t clearly delineated. Key objectives should include:
 
  • A hypothetical income replacement level for long service employees
  • A target participation rate
  • A target average/median savings rate for your employees.

2) Track your progress: A plan performance dashboard is easy to create – and allows you to track your plan against your stated objectives.

3) Close any gaps: If gaps emerge between your actual plan experience and your targets, work with your provider to develop measurable action-oriented interventions or campaigns to close these gaps and get your plan and plan members back on track.

4) Review your plan regularly: Change is a constant in the CAP industry – and a fresh eye is needed on a regular basis to assess how these changes could impact your plan. Conducting a thorough plan design review every 5 years – looking at features beyond the investment line-up – can go a long way to ensuring that your goals and those of your employees are met.
 
Much of the conversation with pension committees is typically focused on plan assets, their asset mix distribution and fund performance. But at regular intervals, plan design considerations deserve time on centre stage. It can be highly worthwhile to revisit your plan’s purpose, set goals for what the plan is expected to achieve and then collaborate with your plan’s provider and professional advisors to measure the plan’s success against those defined goals.

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 Mazen Shakeel
 Vice President, Market Development, Group Retirement Services
 Sun Life Financial



 

Mazen leads the Group Retirement Services (GRS) teams responsible for marketing, investments, product development and research. He develops and implements business strategies that enhance our existing business model for GRS and Sun Life Financial Canada. Mazen also works closely with clients as the executive partner for a number of GRS client relationships.

Mazen possesses a wealth of experience in the retirement industry and a deep focus on investment solutions. In his previous role with Sun Life, he led the International Investment Centre, an internal consulting group supporting Sun Life businesses around the world, including GRS.

Prior to joining Sun Life in 2013, Mazen spent 24 years with a leading human resources consulting firm where he held diverse, progressive positions in client management and retirement consulting. In the latter case, he held both defined benefit and defined contribution consulting teams.

Mazen holds a Bachelor of Science degree from the University of Toronto and is a Fellow of the Canadian Institute of Actuaries, as well as a Fellow of the Society of Actuaries.