North Dakota is currently considering legislation that, if enacted, could default most new state employees into the state’s defined contribution (DC) retirement plan. A retirement plan can be designed in any number of ways and the effectiveness of the design will depend on how that plan meets the needs of employees, employers, and others impacted by the plan.
Currently, the North Dakota Public Employees Retirement System (NDPERS) has a traditional defined benefit (DB) pension plan for most state and local government employees but also offers to a limited set of state employees the choice of electing to participate in a defined contribution retirement plan instead of the pension plan.
The optional NDPERS DC plan was available to most employees from 2013 to 2017, but effective August 1, 2017, the special enrollment period to all permanent employees ended and plan eligibility returned to just a limited number of employees. With the legislature poised to potentially take a major step by making this optional DC plan the primary retirement plan design for most new state workers outside of higher education, public safety and the judiciary, this analysis examines how well the current North Dakota DC plan meets certain best practice retirement plan design principles and where it may fall short on others.
Strong Contributions Create Foundation for Employee Retirement Security
The greatest strength of the NDPERS DC plan is in its contribution policy. Employee contributions are 7 percent of salary (4 percentpicked-up by the employer and only 3 percent deducted from payroll). Employer contributions are 7.12 percent of salary. This total 14.12 percent of salary adequately meets the contribution recommendations by many retirement experts for non-safety employees, especially considering that participants in this plan are also in social security. This is a contribution schedule that, over a career of employment and combined with Social Security and personal savings, will produce a retirement income that allows plan participants to maintain their pre-retirement standard of living.
One consideration worth noting is that the DC employer contribution of 7.12 percent is the same as in the DB pension plan. While the rates between the two plans are not linked statutorily, the legislature should make clear that there is no link between the contributions in the two plans; different factors and policy considerations are used to determine the proper contribution rates in DB and DC plans so it is never a best practice to have the two linked.
Areas for Improving the Current Defined Contribution Plan
Outside of the strength of plan contributions, several important areas of the NDPERS DC plan are not consistent with best practices in DC design. The first among these is unfortunately common in many retirement plan designs today. Plan objectives are not fully and clearly defined in the governing statutes nor any material that participants or others can easily access. In the Statement of Investment Policy for the DC plan, NDPERS states, under Objectives of the Plan, that, “The Plan is a long-term retirement savings option intended as a source of retirement income for eligible participants.
Without a more comprehensive statement of objectives, it is not surprising that the current DC plan lacks certain features that would help it better meet employer and employee long-term retirement needs. It is also impossible to measure the plan’s effectiveness if its very objectives are unclear.
For the sake of this analysis, the objective of the NDPERS DC plan should be to meet employer workplace needs in the recruiting and retention of qualified workers and for the maintenance of an employee’s standard of living through retirement, in combination with Social Security and personal savings, following a full career of employment. (Note that this statement does not specify that the “full career of employment” is with one employer.)
The objective should further include that this benefit is provided in a cost-efficient way without the creation of unfunded liabilities. Preferably, the actual statement of objectives would be comprehensive and detailed enough to include specific income replacement goals and cost targets.
Perhaps the greatest shortcoming that is evident regarding the North Dakota DC plan today is that its very existence may not be clear to those eligible to participate in it as there is very little marketing or promotion of the DC plan.
The DB plan is referred to as the “main” retirement plan, implying, if not outright stating, that the DC is a lesser option. If the current legislative discussions result in defaulting most new hires by the state into the DC, both NDPERS and state employers will need to develop robust ways of helping to articulate the benefit to new hires and communicate the value of this option to those entering the retirement plan.
Improving the Investment and Distribution Options for Participants
Plan investments available in the NDPERS DC plan present a mixed bag of positives and negatives. To the system’s credit, they offer a solid mix of investment funds with acceptable fees and also have a series of target-date funds, also well priced, for participants preferring a “one-choice” option. The number of available funds is not overwhelming nor is it repetitive.
On the downside, there are no deferred annuities offered in the investment menu thereby limiting employee flexibility in preparing for retirement income. Also, it would be preferable to see some guaranteed investments included in the target-date portfolio constructions, again enabling better retirement preparation for participants.
Additionally, asset distribution options available under the DC plan are not consistent with a retirement plan designed to meet the key objective of predictable and stable post-employment income. The standard distribution method offered under the DC plan is a lump-sum withdrawal upon separation from service. The employee can roll this distribution over to an IRA or take periodic distributions. Lifetime annuity purchases are only available by the employee purchasing such annuity on the open market with the lump-sum distribution.
While common, these distribution choices limit the attractiveness of the DC plan as a core retirement plan. The plan sponsor could require annuitization of some or all assets (as they do in the DB plan) but they do not, effectively treating the core DC retirement plan as a supplemental savings plan. DC plans can do better in terms of operating as a true core retirement plan and meeting lifetime income security for employees.
Benefit portability is a key strength of most DC plans. That, however, is limited in the NDPERS DC plan. Savings attributable to employer contributions are vested for the employee over four years of service. This vesting schedule is not ideal and inhibits retirement benefit portability. Full and immediate vesting would be preferred. This schedule also treats defined contribution plan participants less favorably than the DB plan, which vests over three years. The DC vesting period should be reduced from its current level to enhance portability and value for the state’s future workforce.
Improved Disability Provisions Needed for Plan Participants
Finally, the DC plan does not include provisions for disabled employees other than giving them the ability to withdraw assets from the plan. A simple solution to this deficiency would be for the plan sponsor to slightly lower the employer contribution (likely by less than 50 basis points) and purchase insured disability benefits for all participants in the DC plan.
Overall, the NDPERS DC plan has a solid foundation with its excellent contribution rate. With a few simple changes that would add little if any cost to the state, North Dakota’s DC plan could become a model for public retirement plans across the country.
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