7 Practices to Improve Plan Design
As total value of U.S. retirement assets approaches the $30 trillion mark, a truly remarkable number, the picture on the street, however, is not that impressive. According to the findings of the Government Accountability Office (GAO), about a third of those 55 and older have no retirement savings whatsoever with a median retirement account balance of just $2,500 (GAO, 2015). The Employee Benefit Research Institute estimates that Americans have a retirement savings deficit at $4.3 trillion (EBRI, 2015). While it’s true that Americans are ill prepared for their golden years, we can still make a difference. There are proven steps plan sponsors and financial professionals can take today to improve retirement outcomes of pre-retirees and set Generation X, along with the Millennials, on a path to retire with confidence.
The first quarter of the year is a perfect time to map a course; for some, it’s an opportunity to strengthen their resolve and stay the course, while others will choose to fine-tune their roadmap. The process benefits both. Below, we discuss seven practices that focus attention on improving outcomes. It’s not an all-or-nothing proposition. Likely, it is a journey of many steps; each empowering plan sponsors to help their participants reach successful retirement outcomes.
Remove | Many plans impose a one-year waiting period before an employee becomes eligible to participate in a retirement plan. Consider removing that barrier to reduce or eliminate the wait requirement for salary deferrals. You may still keep it in place for employer contributions, such as match or profit sharing. If turnover is a concern, consider establishing a separate employee deferral-only plan for those who have been with the company for less than a year. Special rules allow treating employees admitted into the plan earlier than one year separately for testing purposes. Rather than using semi-annual entry dates, consider immediate or quarterly entry into the plan. Coordinating retirement plan entrance with enrollment into health and welfare plans helps increase participation among employees.
Automate | Rather than expecting employees to voluntarily enroll into the plan, give them an opportunity to opt out. Voluntary enrollment falls short. According to Vanguard’s How America Saves 2017 study, only six out of 10 employees of companies with a retirement plan take the necessary steps to participate in their plan. Much has to do with inertia and procrastination, but a lot is attributed to confusion and simply being overwhelmed with the steps, options, and decisions frequently required of employees to enroll. Make it easy; reduce the steps to one:
opting out of the plan if an employee doesn’t want to continue participating. Multiple studies, including
Vanguard’s, have demonstrated that opt-out rates are low with 90 percent of automatically enrolled participants staying in the plan.
Does auto-enrollment seem too big of a step? Consider quick enrollment, also known as easy enrollment, as a possible alternative. Rather than distributing an enrollment booklet or expecting participants to go through a multi-step online enrollment process, give employees a quick enrollment card that offers a contribution rate, the ability to select an annual percentage increase option, and a simple explanation of a default investment available in the plan.
Step Up | The most commonly used initial auto-enrollment rate is 3 percent. Recognizing that percent may be too low to accumulate sufficient retirement savings, many companies have increased their default contribution rates to 6 or even 8 percent. Since expert-recommended savings rates are typically in the 10-12 percent range (with some recommending savings as high as 18 percent), automatic escalation becomes a helpful tool to encourage employees to gradually reach that savings threshold. The proof is in the pudding, according to the Defined Contribution Institutional Investment Association (DCIIA), survey plans that combine automatic enrollment and automatic contribution escalation have over twice as many participants with retirement savings rates over 15 percent (DCIIA, 2017).
Stretch | Profit-sharing contributions are not very effective in motivating employees to contribute into the plan. Consider reallocating some of the profit-sharing contribution budget to be used as a match and extend match dollars by requiring a higher deferral percent to get the maximum. For instance, instead of dollar-for-dollar up to three percent of compensation, you can redesign the match to 50 percent up to 6 percent of compensation or even 25 percent up to 12 percent of pay. Your budget stays the same but this approach requires a higher deferral rate to take advantage of the maximum employer contribution. Use this approach in combination with auto-escalation to anchor higher deferral percentages.
Simplify | Take a closer look at plan’s investment options. It is considered sensible to limit investments to no more than 10-12 core fund options with additional access to professionally managed portfolios (e.g., lifestyle or target date funds). Keeping a high count of options creates an undesirable effect. According to widely cited research by the Pension Research Council at Wharton, enrollment drops 1.5 percent to 2 percent for every 10 new options offered to participants. Participation increases when participants are presented with fewer and simpler options: there are fewer decisions to make.
Limit | Consider managing access to the number and amount of participant plan loans. Loans are one of the leading causes of savings leakage. Annually, one in nine participants gets a plan loan as an easy way to cover a financial shortfall. Participants who borrow from their plan on average defer two percent less, and one out of 10 loans is not repaid. Both factors have a significant impact on retirement accumulation and readiness.
Re-engage | A set-it-and-forget-it approach is not only detrimental to savings rates, but also investment outcomes. There is a way you can help participants overcome the inertia when it comes to their investment decisions. A new trend has emerged among plans that, in addition to automatically enrolling inactive participants, started to re–enroll all participants in the plan’s qualified default investment option (QDIA), typically a target date fund, every year. Participants are automatically moved into the QDIA on a specified date unless they make a new investment election or opt out of this re-enrollment within a specified time period.
This practice has shown to increase plan participant engagement and is useful to ensure that participants are invested appropriately for their age. Since QDIA is a safe harbor investment under the Pension Protection Act, it helps plan sponsors reduce their fiduciary risk exposure associated with investment.
Doing Well While Doing Good. Really.
There are incidental benefits to plan sponsors. Focusing on participant outcomes helps the employer:
Reduce the costs of delayed retirement. When participants delay retirement, companies spend more money on healthcare coverage. Healthcare costs are also higher for companies whose employees experience high levels of financial stress.
Increase productivity and retention. Financial stress often impacts productivity and results in lower performance. Delayed retirement of senior employees often leads to turnover among younger associates as they see it as an indication of limited career paths and fewer opportunities for promotion.
For discussion purposes only and in no way represents legal or tax advice. A safe harbor plan may not be appropriate in all cases. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.