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A Closer Look at Different Kinds of Retirement Plans

Advanced Design Concepts: Defined Contribution Plans

There are good ways to build DC plans, and bad ways to build DC plans.

DC 1.0 History

The first generation of Defined Contribution plans in the corporate world were designed to be supplemental to guaranteed income pensions. As such, the old school DC plans designed as 401ks were built to target wealth accumulation, not income replacement for retirement. These “DC 1.0” plans over time became primary tools for retirement, but their original design was for supplemental savings. A major set of shortcomings was a lack of adequate contributions flowing into the plans, a poor selection of investment options, and no clear way to convert savings into income.

DC 2.0 History

In the public sector, DC plans were first created to meet the needs of mobile professions, like university professors and city managers. These kinds of public employees are less like to stay in one place, much less one state for their full career, making the backloaded income accumulation aspects of pensions not particularly suitable for their profession. As more and more DC plans have been created in the public sector, they have started to focus on producing sustainable lifetime income.

These “DC 2.0” plans have features that help focus on income replacement and not just wealth accumulation:

  • Employees are required to contribute to their plan—after all, if there aren’t sufficient contributions then the plan can’t help support retirement.
  • Employees are given options on how to invest based on their career goals. Rather than just leaving investment completely up to the individual, well-structured DC plans have a range of mutual funds, index funds, and target date funds, all of which are more straightforward to understand.
  • Plan sponsors provide a qualified default retirement plan so that employees don’t have to make investment choices if they don’t feel confident.
  • Plan sponsors use competitive processes for vendors to bid for providing investment management services to employees, ideally putting pressure on the vendors to drive down fees.
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