Plan sponsors and plan participants are falling down on the job with regard to using 401(k) plans to their fullest potential, and they’re desperate for help.
In a recent survey commissioned by Schwab Retirement Plan Services, 59% of plan participants say their 401(k) is their only or largest source of retirement savings, yet 29% have either decreased or not made any changes to their 401(k) savings rate in the last two years. Just 58% know how much they should save for a comfortable retirement. Two-thirds wish to receive personalized investment advice for their 401(k), but only 12% do.
According to the 2015 “Plan Sponsor Survey” conducted by the LIMRA Secure Retirement Institute, 92% of employers have discussed retirement readiness with their advisors and plan providers, yet nearly four in 10 employers say less than half their employees are well prepared for retirement.
Of course, there’s a difference between discussing retirement readiness and actually doing something about it. And plan sponsors are often slow to adopt ideas. But advisors and other industry experts who’ve persuaded clients to implement their suggestions are seeing noticeable results. Their strategies—which address enrollment, employee education, investment selection and other factors—frequently aim to keep things simpler.
“What prevents 90% of people from participating [in 401(k) plans] isn’t laziness but confusion about the process,” says Andrew DeGroat, a principal with WhartonHill Advisors, an independent consulting and investment advisory firm headquartered in Fort Washington, Pa. “People know that saving money is good, but they’re intimidated.”
Eight to 10 years ago, DeGroat and his colleagues at WhartonHill Advisors, which today provides advisory services to 166 401(k) plans, thought the average investor was becoming more financially educated and would benefit from a greater number of 401(k) investment options. Not so anymore. “We’ve come full circle,” he says. “Less is more.”
On average, the firm’s clients now offer 16 investment options in their plans, plus a money market/stable value fund and risk-based or target-date models. Participation rates for existing non-highly compensated employees have risen as menu options have been streamlined, he says. People are also more focused on how much they should be saving, he says, rather than on sorting out the investment menu.
“We see many new clients that have three world stock funds, plus a foreign large blend, foreign large value, foreign small/mid value,” he says. “Too many redundant, obscure asset classes that confuse people.” To further reduce confusion, he suggests plans offer either risk-based or target-based models, but not both. His personal preference is to offer the former because new participants tend to better understand the risk profile they are assuming when they invest in a risk-based fund, he says.
Instead of annual education meetings, which can be intimidating, WhartonHill Advisors now suggests “drip education”—sending frequent e-mails and quarterly direct mail pieces to employees. After receiving several communications, they generally participate, says DeGroat.
“I’m a huge proponent of auto-enrollment,” he adds. Clients who’ve adopted this feature for newly eligible employees have had just 10% opt out of their plans. “Based on the 63 plans we have implemented auto-enrollment for in the past 24 months, plan participation is 76%, as opposed to 70% in the 12 months prior,” he adds.
He also likes to see auto-enrollment offered to eligible non-participating employees if plan sponsors are able to handle the administrative demands. Here, “Auto-enrollment can be a double-edged sword and a complete disaster for employers because of regulatory requirements,” he says. Plans need a vendor who is very good at integrating with payroll to track eligibility and mail eligibility disclosure notices to employees, he says.
Ken Hoffman, a managing director with HSW Advisors, a private wealth management boutique in New York City, suggests clients include auto-enrollment and auto-escalation features in their plans. “Auto-enrollment is all psychology,” he says. He points to a study showing that Germany, which has only an opt-in system for organ donation, has a low 12% donor rate while Austria, which has an opt-out system, boasts a donor rate of more than 99%.
Auto-escalation, which automatically increases employee deferral rates, is “a harder push,” Hoffman says. Yet according to a 2015 study from Empower Institute, employees whose plans offer auto-escalation are on track to replace 92% of their working income in retirement, while those whose plans don’t offer this feature will replace only 73%.
Employees also require more education on target-date funds and need to know, says Hoffman, “Is this taking me to retirement or through retirement?”
More Ideas
Hoffman encourages clients to create 401(k) non-elective safe harbor plans that offer an employer match to non-highly compensated employees (those earning less than $115,000 in 2014). These plans enable highly compensated employees to defer more income and are exempt from IRS nondiscrimination tests (which ensure that benefits provided to highly compensated employees are proportional to those provided to non-highly compensated employees).
He is also a fan of the “combo” plan, which adds a cash balance plan atop a safe harbor 401(k) plan containing a profit-sharing component. The IRS limits the maximum someone can put away under a 401(k)/profit-sharing plan to $53,000 for those under age 50 or $59,000 for those 50 and older. By adding a cash balance plan, key employees can typically save an additional $75,000 to $250,000, he says. Actuaries calculate this figure using each person’s age and salary.
Brian Holmes, president and CEO of Los Angeles-based Signature Estate & Investment Advisors (SEIA), which manages $200 million in 401(k) assets across 35 plans, says employer matching contributions have a strong correlation to employee participation and deferral rates.
Additionally, “If the employer is constantly emphasizing the importance of retirement readiness, education, communication, and takes an active role in the administration of the retirement plan, we see a vast increase in the participation rates and contribution rates of employees versus employer plans that are not implementing those add-ons,” he says. “The idea of ‘retirement readiness’ truly begins at the employer level.”
Holmes is also seeing more adoption of auto-enrollment. Adding this feature has significantly boosted plan participation among manufacturing clients with low-wage employees, he says.
When SEIA digs into existing and proposed plans to discuss layered fees, “we peel back the onion in all five areas,” says Holmes, referring to the fees for the custodian, record-keeper, administrator, advisor and funds. If a client’s plan hasn’t been updated in a couple of years, moving its lineup into index funds, ETFs and less expensive class shares typically saves 20 to 50 basis points in overall fund expenses, he says.
To improve plan contribution rates, employee education meetings now include real-life examples of employees who start to save earlier rather than later and also include discussions about target-date funds and risk tolerance, says Holmes. As a protective measure, he encourages clients to keep a list of employees who attend these meetings.
Others also emphasize to plan sponsor clients that an ounce of prevention can be worth a pound of cure. Hall & Co., an Irvine, Calif.-based CPA and consulting firm that audits 12 to 15 401(k) plans every year, has talked to clients about the Supreme Court’s recent ruling in favor of plan participants in Tibble v. Edison International. Ellen Bartholemy, director of accounting services for Hall & Co., reminds clients that they need to create and follow plan processes. This includes documenting their thought processes behind their decisions, especially if they hire a more expensive service provider.
Fiduciary duty and fee disclosure remain “hot buttons,” says Bartholemy, who expects to see more 401(k) lawsuits.
The Big Picture
Mike Narkoff, executive vice president of sales for the retirement division of Ascensus, which services 40,000 plans and works with more than 10,000 advisors, is seeing advisors help more plan sponsors pick qualified default investment alternatives (QDIAs).
He notes that approximately 42% of the plans Ascensus converted from existing plans in 2013 and nearly 70% of those it converted in 2014 went through QDIA re-enrollment at the time of conversion. “This is a seismic shift,” he says. “The rate of participants who stay in default vehicles is probably north of 80%.”
Looking ahead, Narkoff thinks the next 401(k) evolution will be the embracement of managed account services, which offer plan participants customized asset allocations and highly personalized savings rate suggestions. “That’s really the end game,” he says. “The traditional enrollment meeting where you try to teach everything and hope employees make good decisions on their own is quickly becoming a thing of the past.”
Joel Lieb, director of advice in defined contribution at Oaks, Pa.-headquartered SEI, an asset manager that oversees more than $10 billion in defined contribution assets, encourages plan sponsors he works with to not just consider fees and performance but also the experiences they are providing to their plan participants.
Plan sponsors shouldn’t be afraid to take a more paternalistic approach toward helping plan participants get to healthy income-replacement ratios. Despite some initial resistance, he says most plan participants are OK with their employers taking a more active role and putting them in QDIAs.
Lieb hopes to see an emergence of customized defined contribution models that, like defined benefit models, are built around participants’ objectives. “The conversation is becoming more important as the workforce ages,” he says. “The defined contribution plan is no longer the supplemental plan.”
He’d also like to see more ways for plan sponsors to get involved in post-retirement engagement—helping employees figure out how to invest their money after retirement and protect assets throughout their lifetime. IRS guidance is needed first, he says.
He also encourages advisors to keep pitching plan-improvement ideas to their employer clients. “Plan sponsors set in their ways are generally interested in hearing what folks are doing in the industry,” he says, “even if they’re not ready today.”