January 13, 2021
The novel coronavirus (COVID-19) pandemic and resulting economic crisis have severely hit people’s financial wellbeing. The pandemic has already caused nearly three in 10 Americans to decrease or stop saving for retirement, according to a recent survey. Meanwhile, in the U.K., the number of people over 55 who withdrew cash from pension funds from July to September 2020 increased 6 percent compared with the same period last year.
Even before the pandemic, workers were challenged in trying to save enough for retirement. Aon research found that only one in three U.S. workers will save enough to retire comfortably by age 67. There are ways employers can help their workers lessen the pandemic’s impact on their retirement savings and maintain appropriate savings levels once the crisis has passed. Organizations can help employees get on — and stay on — the right savings track through effective communication designed to specifically address the crisis and provide the right resources to assist workers in making informed decisions about their retirement savings. On top of that, adjusting the design of retirement plans and their offerings can allow companies to better meet employees’ needs and speaks to a growing trend. As businesses look for ways to help employees close retirement savings gaps, retirement plans are evolving.
“Changes in employees’ needs, greater diversity of the retirement experience and new legislation are sparking an evolution of the defined contribution plan,” says Beth Halberstadt, U.S. Defined Contribution Investment Solutions leader at Aon.
Over the past few decades, workers have become increasingly responsible for the adequacy of their retirement savings as defined contribution retirement plans have largely replaced defined benefit programs in the private sector. In 1990 in the U.S., defined contribution 401(k) plans held approximately $380 billion in assets. By 2019, the figure was more than $5.6 trillion.
While defined contribution plans have become more prominent, they require workers to save and invest properly if they’re going to be financially prepared for retirement. Aon estimates that the average worker needs to save 11.1 times their final annual income to be properly prepared for retirement.
Longer life spans coupled with inadequate savings are making it less likely that many workers can retire comfortably. Even before the pandemic, some faced the possibility that they might outlive their retirement savings. Now, as many employees face reduced family income, they are pausing or even cashing out defined contribution plan savings to get by.
In the U.S., the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, expanded the ability of individuals affected by COVID-19 to draw down funds from their retirement plans without having to pay the usual tax penalties for early withdrawals.
However, employees need to consider the consequences before making changes to their retirement plans. “For those people who have had to stop saving or take a distribution, there will be a significant retirement savings impact,” says Grace Lattyak, partner at Aon Retirement Solutions. The effects might be particularly pronounced among those industries hardest hit by the pandemic, she said.
The pandemic demonstrates that unexpected events can affect people’s ability to save. But employers are increasingly looking for ways to reduce employees’ stress as they look to save for retirement, then live comfortably on those retirement savings once they stop working. As they do so, it’s becoming increasingly clear: Changes are coming to defined contribution plans.
Getting Employees Through — Not To — Retirement
Employees’ retirement roles can be thought of in two phases: They’re savers during working years and spenders once they retire, Halberstadt says. Historically, employer support has focused only on the employee savings phase. But employer support has begun to extend into the postretirement phase, with companies looking to offer better retirement income options and reevaluating plan design and investment options.
“As the employer mindset changes, the retirement savings industry is shifting as well, adjusting its model from a single savings phase to a more comprehensive strategy that accounts for both the savings and spending phases of employees’ lives,” says Halberstadt.
Halberstadt says employees need a variety of tools to choose from to execute on that strategy:
- Looking for professionally managed solutions — Target date funds and managed accounts see employees through both the saving and spending phases.
- Looking for lower cost access — Passive management helps employees through the saving phase, while multi-asset investments can assist them in the spending phase.
- Looking for outperformance — Active management can improve the performance of employees’ savings during the saving phase, while annuity products can increase their financial security in their spending years.
The result: Plans need to expand their investment tools so they can play a role in both the savings and spending phases of a participant’s life stages.
A More Customized Retirement Journey
The journey to and through retirement is no longer typical. More than 40 percent of employees expect to work part time before starting full retirement, and increasingly those workers are looking for options in the way they tap their retirement savings.
As a result, three out of four plan sponsors surveyed by Aon will begin allowing employees to take partial distributions during retirement. And 60 percent are allowing plan distributions to be paid out over a fixed number of years.
Other plan participants are looking for more consistency with their retirement funds.
“Employees are asking for more guaranteed income in retirement,” says Melissa Elbert, partner at Aon Retirement Solutions. “So, we’re starting to see more interest from employers to help them solve for that. That reliability was a perk with defined benefit plans. But with defined contribution plans, employees typically retire, take their money and then need to manage it over the rest of their lives. They don’t know how long they’re going to live or what their spending needs will look like. There are ways employers can help them better manage that risk.”
Aon’s survey showed high demand for guaranteed income: 80 percent of plan participants said they want some form of it in retirement, and more than 70 percent of employers agree their retirement plans should include an option for it. That’s leading many employers to consider retirement income features (such as annuities) in their defined contribution plan mix.
Among other measures intended to encourage retirement security and improve financial security for retirees, the U.S. Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 makes it easier for employers to offer a retirement income option in defined contribution plans.
Employers Join Forces To Improve Retirement Savings
The SECURE Act also introduced a new savings opportunity for employers and their employees: participation in pooled employer plans (PEPs). Under an open PEP, employers from all industries and sizes can band together to offer employees defined contribution retirement plans.
“PEPs can allow participating employers to take better advantage of investment solutions and administrative platforms,” says Elbert. “This means employees will be paying less in fees and so they’re going to have more assets in retirement, resulting in better outcomes.”
While PEPs were originally focused on small to midsized employers, their benefits are attracting larger employers as well, and could eventually become the dominant retirement plan structure in the market.
“Many employers are seeing the advantages of shifting plan management responsibilities to the pooled plan provider. They’re able to focus on essential business activities while also lowering fiduciary risk,” Elbert says.
Employees’ Needs Evolve, Retirement Plans Adapt
The COVID-19 pandemic has highlighted some of the vulnerabilities in retirement savings programs, but many employers were already aware of the need to adapt their retirement plans to employees’ changing requirements.
The result is the defined contribution plan of the future is taking shape.
“As plan participants’ needs extend from ‘to retirement’ into ‘through retirement,’ we expect that plan sponsors will evolve plans to match,” says Halberstadt. “We expect that these customizations will include investment solutions focused on enhancing retirement income choices. Above all, the defined contribution plan of the future will allow for a more custom retirement journey and invite employers to partner up in the name of supporting employees’ resilience beyond their working years.”