Asset Allocation for Defined Contribution Plans

Defined contribution (DC) plans, including supplemental plans, are an important financial element of public-sector retirement that help participants attain their retirement goals. Plan sponsors have a responsibility to understand structure, costs, and fees of the plan.

A large and increasing number of state and local governments provide some form of a defined contribution retirement plan for their employees, in most cases a voluntary deferred compensation arrangement under Section 457 or Section 403(b) of the Internal Revenue Code. These arrangements may be in addition to, or in lieu of, a traditional defined benefit pension plan. Under most defined contribution plan arrangements, the participating employees self-direct investment of the funds credited to their individual accounts from a menu of investment options selected, or offered, by their employers.

1. To provide adequate diversification, plan administrators should ensure participants are offered a broad spectrum of investment choices that include all the major asset classes (e.g., equities, fixed income, and cash equivalents). The investment choices should include several passively managed investment options such as low-fee index funds. Another option is a family of asset allocation funds.[2] In addition to mutual funds, plan administrators should consider lower-cost commingled funds and separate account funds as investment options.
2. The investments provided should be screened for sales charges, fees, and expenses; the age and size of the fund; the fund’s past performance; the fund’s risks, turnover rate, and volatility; and recent changes in the fund’s operations, including changes in fund managers. When choosing investment options, keep in mind that too many investment options can confuse participants and even reduce participation in DC plans.
3. The investment structure should be broad enough for proper diversification, and also to accommodate participants’ varying levels of risk tolerance. Investment choices should also accommodate the needs of different age groups and retirement goals, taking into account participants’ preferences regarding an income stream throughout retirement, lump sum distributions, and the desire to leave money to heirs.
4. The plan sponsor should make asset allocation tools, including software, literature, or consulting services, available to participants. Access to personal financial planning services should be offered as part of the investment program, and any additional fund fees or expenses required for these products should also be disclosed.[4]
5. Record keepers should provide participants and plan sponsors with quarterly summaries of their investment portfolios by asset class and with benchmark comparisons. Where possible, graphs with comparative information should be included.
6. Participants should be regularly reminded of their need to review and update their asset allocations as they age or experience various life events. For example, a reminder might be issued to participants as they cross certain age levels or change employment status.