The defined contribution (DC) plan has become an increasingly important part of retirement planning in Europe, and experts believe it will continue to gain ground going forward. However, they argue, many of the issues that typically plague DC plans–low participation rates, too many investment choices, and lack of a viable default option, among others–are much more prevalent in Europe than in the U.S., and European countries need to address these before they can move ahead.
“One of the most controversial aspects of implementing choice is whether participants are able to carry out their investment decisions,” says Waldo Tapia, a consultant at the Organization for Economic Cooperation and Development (OECD) in Paris. “Empirical evidence shows that many individuals are not particularly good at the retirement savings problem either because they lack the necessary cognitive ability to solve the optimization problem, because they have insufficient willpower to execute it, or even sometimes because they are overconfident.”
As such, an increasing number of European countries are showing an interest in implementing lifecycle/target date funds, Tapia says, to help eliminate the confusion many participants feel when faced with too many investment choices. “These funds can also help participants manage their pension funds when they have neither the knowledge nor the commitment to design and manage their own portfolio, or when they feel that they have the commitment to design and manage their own fund portfolio, but insufficient knowledge to do so,” he says.
To be sure, the lifecycle fund is the way forward for successful DC plans, says Damian Stancombe, head of employee benefits at actuarial consulting firm Punter Southall Financial Management in London. But in most of Europe, particularly in the United Kingdom, the uptake of these types of funds as a default option is a slow process, he says. “We do understand the weaknesses inherent in a lifecycle fund, notably that it doesn’t take into account market ups and downs, but is structured only to move from equities to fixed income,” Stancombe says. “But even so, it is the best option and definitely the way forward for DC plans. The problem is that there is no real thought process going on, at least here in the U.K. There is no real intelligence on lifestyling.”