The "last frontier" in the defined contribution landscape is the Taft-Hartley marketplace. Many private-sector employees participate in these defined contribution plans and likewise many workers in the public sector are part of a 403(b) or 457 plan. Employers and employees alike have welcomed such participant-directed plans because they are flexible, portable and beneficial to both groups.
But unions have been slower to adopt these types of plans than their private-sector counterparts. While many unions do offer annuity plans in addition to traditional defined benefit pension plans, most annuity plans are still trustee-directed.
Still, the frontier landscape is changing, and we estimate some 60% to 70% of annuity plans will have adopted participant directed plans within five years. This is the future, and if it's done right, it's a positive thing.
Annuity plans were first introduced as supplements to union pension plans in the late 1960s. Because they are part of collective bargaining agreements, funding is part of each union member's overall pay.
For the first 20 years, annuity plans were trustee-directed and almost always invested in fixed-income securities. That was a good thing in the 1970s, when fixed income had fairly high returns.
During the current bull market, though, the difference between bond and equity returns has been startling. As a result, many unions moved to a more balanced allocation of 25% or more in equities.
In the mid-1990s, many union members - particularly those in the building trades - began to push for more member direction. With financial information now ubiquitous and investment education commonplace, many workers wanted to play a role in managing part of their retirement assets. One of the first unions to adopt full member direction was the Uniform Firefighters Association of New York City in 1995.
Also, many tradespeople have spouses with 401(k)s that invest in equities. Since equity exposure clearly has been an important tool for portfolio growth during the last 10 years, this helps explain why many members want to tap the equity markets.
Member-directed plans also often allow the original stable value or fixed-income investment to "map over" into the new plan for those who want to maintain the existing approach. Sheet Metal Workers, International Association, Local 28, just converted its plan to partial member direction, while maintaining its original core investment philosophy.
Offering funds with proven track records and managers, and with recognizable names, is a great way to encourage members to diversify and learn more about investing, not to mention that it satisfies the Department of Labor's 404(c) guidelines.
Diversification may not happen overnight. So far, we've found that many members stay in the original stable value investment for the first six months before venturing into the new investment elections.
Traditional annuity plans may be fine for older workers who benefited from sizable bond returns in the late 1970s. Those workers likely are sitting on a good sized nest egg now and are more interested in preserving capital than in growing it.
But younger workers need their portfolios to grow more quickly than fixed income currently allows in order to achieve retirement goals. A member-directed plan with access to equities that also maintains a stable value option can make the plan work for participants in all life stages. We recommend that trustees seeking to make such a change consider these suggestions:
* Provide tailored education, which helps build excitement about and interest in the plan. You can have the best investment options available, but if the members do not understand asset allocation, the overall plan will not be a success and could even harm members. Education must be continuous and proactive.
* Back up the plan with solid technology that address the needs of members, or it won't be used effectively. Make sure the platform is suited to today's daily-valued environment.
* Limit investment options. Too many choices may confuse people, while too few can bore them. We've found that 10 to 15 is a good compromise.
* Unmask hidden costs - a lot of fees can be buried. If a plan provider says "we do it for nothing," stay away.
* Choose a provider that knows the Taft-Hartley marketplace. 401(k) plans and member-directed annuities are not the same. Unions have members, not employees. While the mechanics of annuities and 401(k) plans may be similar, annuities require a higher overall level of service.