More and more American workers depend on defined contribution plans to fund their retirement, but DC plan participants are not on track to sufficiently fund their goals, according to a new white paper from BNY Mellon.

DC plans, it said, have relied too much on retail investment solutions and limited access to alternative investments, have been unable to integrate automation and education and have inefficiently priced products and services.

Now, DC plan sponsors are adopting best practices of defined benefit plans as a way to increase the efficiency of their plans, according to the paper.

Their top priorities for improving current DC plan offerings are increasing the use of low-fee institutional vehicles, using alternative strategies and generating an income stream during retirement.

The paper reflects insights from a survey of 20 plan sponsors from Fortune 500 corporations with billions in DC assets; many have large DB plans.

The survey found that mega-market sponsors expected a 65% increase in use of alternatives to mutual fund vehicles. By 2020, 70% expected to use collective trust funds and 65% separately managed accounts, both of which have costs or fee advantages over mutual funds.

Thirty-five percent of sponsors said they would reduce their reliance on mutual funds.

According to the report, a number of sponsors are turning to white-labeled options as a way to simplify their investment offering and reduce fees. These private funds typically have lower costs than mutual funds, it said.

White-labeling involves grouping various investment managers, asset classes or investment styles under a descriptive name that describes the strategy.

DC sponsors also plan to rely more on alternative investment strategies in the expectation of getting closer to DB plans’ level of returns, with 30% planning to add hedge funds or liquid alternative funds by 2020.

“Many of the principles and best practices of DB plans can be used to enhance the performance of today’s DC offerings,” Dan Smith, BNY Mellon’s head of asset servicing for the Americas, said in a statement.

“DB plans typically outperform DC plans, sometimes by as much as two percentage points per year. That’s an important motivator for DC retirement plans to offer asset classes their investors haven’t been able to access in the past.”

Alternatives can also provide participants with downside or inflation protection, Smith said.

Lifetime Income

DC plan sponsors understand they must focus on lifetime income. Fifty-five percent of sponsors said the need to focus on longevity risk over the next five years by generating retirement income was the biggest driver of DC change.

The paper noted, however, that while DB plan participants know their monthly pension payments, DC plan participants are unsure what level of assets they need to acquire and how that will translate into retirement income.

“In fact, most employees participating in DC plans are allocating between 3% and 6% of their salaries, which happens to be the default range on many auto-enrollment DC plans,” Rob Phillips, senior vice president for consultant relations at BNY Mellon Investment Management, said in a statement.

“However, 10% is a more realistic number to help employees attain their retirement funding goals.”

The paper reported that some sponsors had made lifetime income a reality for beneficiaries by engaging with insurers to wrap annuities into custom target date funds.

— Check out Corporate Pensions’ Funded Status Drops Again in April: BNY Mellon on ThinkAdvisor.