The public sector is far-reaching, spanning many professions across government agencies, including schools, hospitals, research organizations and more. With such an extensive network of employees, the public sector retirement plan space touches far more individuals than one might first assume.
Historically, public employers have offered retirement plans through the defined benefit (DB) plan structure, which offered better than average benefits.
However, as the retirement industry evolves, so too do the benefits employers can offer their staff. Plan sponsors in the space must be strategic in their approach to appropriately navigate the changes while ensuring retirement security for their employees.
Over the last 50 years, this space has changed vastly due to improvements in technology, investment access, methods of employee education and shifting of liability. However, the public sector has changed even more radically due to a June 2012 decision by the General Accounting Standard Board (GASB), which changed the rules of calculating and reporting liabilities of pension plans sponsored by public employers.
Most notably, public employers must provide disclosure of their pension plan obligations on their annual financial statements to the public. The consequences of these disclosures are not yet fully realized.
While full disclosure is a good thing, these GASB rule changes have made public employers think about the structure of their pension plans, how to limit unintended negative impacts on their organizations, and what best practices should be implemented going forward.
On the flip side, corporate employers have moved to transition plans from DB to defined contribution (DC) plans.
According to EBRI, 38 percent of private sector workers were covered by a DB plan in 1979, compared to only 12 percent in 2014.
Conversely, private sector employers covered 17 percent of employees via a DC plan in 1979, and jumped to 44 percent in 2014. The move to DC is developing in a similar way within the public sector space, although there are a few considerations to keep in mind that will affect government employers:
- Public employers are bound to state law that requires its agencies to offer a DB plan. This is applicable in all 50 states.
- Many public sponsors would need to fund current DB plans to convert to a DC plan.
- Many public employers have collective bargaining arrangements with their unions that will require a re-negotiation if they want to convert retirement plan types or benefits.
Even with these considerations, it is only a matter of time before regulatory changes are made to force the switch to DC plans.
In the changing environment of public sector retirement plan offerings, confusion often arises when reviewing plan design, features and investment providers.
So what should plan sponsors look for when evaluating their options within the public sector retirement space? I outline a few keys features and products below.
Plan design features that make a difference:
- Auto-enrollment: Most state DB plans require participation as a condition of employment. Auto-enrollment accomplishes the same thing. Plans adopting auto-enrollment have a 90 percent participation rate, according to Vanguard. Most employers start their staff at 3 percent deferral rates.
- Auto-escalation: Studies conclude that participants should save 10 to 15 percent of salary to have enough to retire. Implementing auto-escalation with auto-enrollment aids employees with saving and avoiding the “analysis paralysis.” Typically, these features increase the employee’s contribution rate by 1 percent each year, with a maximum rate of 10 percent.
Investment products designed to benefit savers:
- Managed Accounts: Rather than having an employee construct their portfolio, employers can hire financial advisers to develop managed account options. This takes the guesswork out of selecting investments and offers a more approachable option.
- Deferred annuity income options: Creating a distribution plan is one of the most critical aspects of controlling your own retirement. An increasing trend for DC plan distributions is to add income annuity options inside their 457(b) or 403(b) plan. The options inside these annuities can be flexible, which gives DC plan assets an advantage in creating a distribution plan to meet retirement living plans.
Along with the changing environment, shifting of risk and helping employees achieve retirement goals, public plan sponsors should establish best practices to ensure their DC retirement plan is up-to-date and taking advantage of the changing regulatory and investment environments. Below are a few best practices:
- Establish a retirement investment committee: This committee should meet regularly to discuss retirement plan policy, features and design; investment products, including fees, performance, changes in policy and new products being delivered to the marketplace; and regulatory changes, along with recordkeeping and plan operation features.
- Create a communication and education strategy: Education materials should include information on enrollment, investment and plan distributions. General financial education like budgeting, taking out a mortgage and how to buy a car may also help remove the temptation to use retirement assets for non-retirement items or purchases. Develop a way to explain the retirement plan options through various life stages, using online interactive calculators or videos to make them relevant and interesting for participants. Additionally, leveraging technology to evaluate events and preparing for in-person education (for example, creating a “what retirement means and how to do it” seminar that would provide information for those preparing for retirement), would be beneficial.
- Monitor and benchmark: State law may require plan sponsors to compare fees for plan operations and/or completely bid retirement services and investment options every three to five years. In the last 10 years, the costs of investments and services have been reduced by 50 percent or more. The retirement committee needs to actively be looking at ways to benefit their employees. They should ask their adviser about new trends happening in the marketplace and define how employees will benefit from new products, services, or technology. There are many advisers that have expertise in the public DB/DC market that can guide you through the review and selection process. Hiring the right one can bring professional help and information for the committee to make the right decisions.
In an evolving environment, change is sometimes hard. Whether change is regulatory, technology related or just the right thing to do, developing a plan to implement and identify positive benefits will help guide an organization through the changes and lead to the right outcome.
Troy Dryer is Vice President of Business Development at Investment Provider Xchange (IPX), a single-source end-to-end solution for providers in the 403(b) and 457(b) plan markets. He has more than 25 years of experience in the retirement plan industry, serving in various management, sales, client relationship management and product leadership roles.