A defined contribution plan provides funds for retirement based solely on the assets available in an employee’s individual account, and all investment-related risk is borne by the employee. Defined contribution plans can be offered as the primary retirement plan or as a supplemental retirement plan. Separate recommended practices have been adopted for Defined Benefit Retirement Plans and Hybrid Retirement Plans, and they should be consulted accordingly. The fundamental goal of retirement plan design is to adequately meet the needs of employees, consistent with the plan sponsor’s available resources.
Governments consider many elements in a comprehensive retirement plan design, including:
- Provision of disability and survivor coverage in place.
- The advantages and disadvantages of lump sum payments, roll-over options, annuity purchase options, and periodic payment options.
- The potential use and liability of offering investment advice and financial education.
- A plan for effective communication and reporting to participants.
- Board governance policies and practices.
- Plan features that can provide tax diversification and flexibility as allowable (e.g., pre-tax and after tax contributions).
Once public plan sponsors develop a policy statement that will guide their plan design decisions, they need to decide upon the essential elements of the primary retirement vehicle.
Should an employer choose to provide a defined contribution (DC) plan as the primary retirement vehicle, GFOA recommends that retirement administrators and finance professionals include the following design elements:
- Conduct analyses, including a full actuarial analysis, based on workforce demographics and the desired level of replacement income to determine the related cost of providing the benefit.
- Determine whether employees are eligible for a federal insurance program that provides benefits to retired people (e.g., Social Security).
- Provide a tax deferral to employees through the use of mandatory employee contributions.
- Evaluate possible employer matching to promote voluntary savings. Determine whether an employer match will be offered, and if applicable, the formula most likely to accomplish the desired level of contributions.
- Institute a system for automatic enrollment and default investment options.1
- Establish plan contributions based on a percentage of pay, rather than a flat dollar amount.
- Establish an automatic increase to employee contributions, which could be annual or tied to pay increases.
- Create a governance structure that provides for, at minimum, an annual review of plan design elements including investments and services. The review should be conducted independent of the plan provider.
- Establish a sound investment structure and policy2 that addresses the reasonableness of fees3 and the quantity and quality of investment options (e.g., investment options that adequately addresses employees’ investment strategies but do not overwhelm participants with unnecessary choices).
- Develop, implement, and monitor the effectiveness of a participant education program.4
1 The automatic enrollment and default investment options under the Employee Retirement Income Security Act (ERISA) do not apply to governmental plans; however, for governmental plans residing in states that do permit automatic enrollment, ERISA may provide an existing framework. See sections 902 and 624 of the Pension Protection Act of 2006 or sections 514(e) and 404 (c)(5) of ERISA.
2 See GFOA Best Practice, Investment Policy.
3 See GFOA Best Practice, Investment Fee Policies for Retirement Systems.
4 See GFOA Best Practice, Participant Education Guidance for Defined Contribution Plans.