A new and promising Dutch pension innovation is now being embraced in the U.K., and it’s all but certain to get a close look in the U.S. in coming months. Say hello to your likely future: the employer sponsored defined-ambition plan.
The name doesn’t tell you much. It’s an obvious play on the two most common types of employer-sponsored plans: the defined-benefit plan, also known as a traditional pension, and the defined-contribution plan, most commonly a 401(k).
By now, most people understand that employers generally have swapped out their traditional pensions for 401(k) plans. This takes them off the hook for providing specific levels of guaranteed lifetime income, a prospect that grew outrageously expensive as life spans expanded.
Longer lives remain a distinct risk for pension providers. The British researcher and longevity expert Dr. Aubrey de Grey believes the first person who will live to 150 is alive today, and that within 20 years the first who will live to 1,000 will already have been born. He may be reaching for shock value. But the point remains: lives are growing longer all the time and employers will not want to guarantee income to infinity.
The defined-ambition plan gets around that. It is best thought of as a hybrid that moves some risk for guaranteed retirement income back to employers—but without handcuffing them should their actuarial models fail or their investment returns lag. The pension benefit would be adjustable. The level of income might be reduced or eligibility might be pushed out to, say, 69 from 67—or to 120 if we’re really going to live to 150. This adjustment would keep the plan fully funded without requiring an employer to kick in more cash.
Companies in the Netherlands, where the pension system has long been highly regarded, are already rolling out defined-ambition plans. That country never embraced the 401(k) model and only in the recent downturn found poor investment returns made traditional pensions unsustainable. They are moving directly to the defined-ambition model. In just the past few weeks, the U.K. has taken steps to move that direction as well.
There has been little public discussion of defined-ambition plans in the U.S. But officials can’t help but take note of the transition overseas. Guaranteed income is retirees’ top concern and has emerged as one our pension system’s biggest failings.
The typical worker retiring today has only Social Security to guarantee monthly income for life. The push is on to build income-generating options into 401(k) plans by offering deferred annuities within the plan and a seamless conversion to annuities with a portion of 401(k) assets upon retirement. One in five employers expect to introduce such a choice in the next 12 months, according to a BlackRock survey. So in a sense, companies in the U.S. are already thinking in defined-ambition terms. The missing piece is some level of employer guarantee.
Why might employers, having taken decades to exit the defined-benefit model, now back track at least partly? A defined-ambition plan likely would come to be seen as a valuable benefit that helps them attract and keep the best workers, especially highly mobile Millennials, who crave investment certainty. In an Aegon survey, twentysomethings named as their top investment priority products that offer guaranteed retirement income.
The basic idea of a defined-ambition plan is for employer and employee to share the risk of retirement income equally. That could be done in many ways. The Dutch version favors setting a benefit level based on current trends and allowing employers to adjust if trends change. The benefit may go down; it will never go away. The employer guarantees income—just not how much.
In the U.K., the government has proposed a different approach. It wants to remove restrictions forcing employers that offer a traditional pension to raise payments each year for inflation and to provide survivor benefits. This makes the expense far more manageable from an employer perspective, and employees own the risk of inflation and taking care of their spouse.
One way or another guaranteed income is coming back as a staple in our pension system. The 401(k) simply has not worked out as a primary retirement savings vehicle; everyone wants change. The defined-ambition approach makes sense. A cynic might say that’s why it will never happen here. But I expect we’ll be hearing more about it in the near future.