Healing Powers for Sick 401(k) Retirement Plans

Participation can be greatly improved through auto features.

The ancient Greeks looked to Hygeia, the goddess of health and medicine, to protect them against illness and to heal what ailed them. Her powers of healing would be very useful for many of today’s 401(k) plans that are struggling with subpar participation, anemic contributions, broken plan designs and other maladies.

Judy Diamond Associates, which tracks publicly filed retirement plan data, announced in June that nearly 60,000 401(k) plans failed their most recent nondiscrimination tests. The failures meant that $794 million in retirement plan contributions had to be returned to highly compensated individuals, frustrating the owners, managers and executives for the companies that sponsored the retirement plans. (See “States With the Most Corrective Distributions.”)

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It’s a problem that you might think only a goddess could solve. Instead, it can be attacked one retirement plan at a time—not by a goddess—but by a financial adviser or other retirement plan expert who follows a simple, solutions-based three-step process defined by analysis, prescription and re-evaluation.

Consider a case study involving a printing plant with a 401(k) plan, more than 2,000 eligible employees and a 20% participation rate. Of those who did participate, only 26% were on track to replace at least 75% of their income at retirement at age 67. Replacement income included all sources of retirement savings as well as Social Security. Participants cited a lack of matching contributions by the employer as the reason for not contributing to the plan or not contributing more.

Analysis: With so few employees participating in the plan—and fewer on track to retire at an age when most people qualify for full Social Security benefits—the plan sponsor was potentially staring at significantly higher costs in future years. Employees who are not financially prepared to retire at 67 can be expected to continue working through their 60s and possibly into their 70s. That can mean higher costs for salaries, health care and disabilities, both work and non-work related.

Although the plan was not failing its nondiscrimination test, the low participation rate could lead to just such an outcome. Those who participated in the plan deferred an average of 5.77% of pay.

Although the institution of employer matching contributions to the plan could potentially increase participation rates, closer examination revealed that the employer couldn’t afford the costs associated with a match. Hygeia would prescribe alternative medicine.

Prescription: Employees at the printing plant had been asked to opt-in instead of opt-out of their 401(k) plan, a passive strategy that not surprisingly led to the sickly participation rate. Furthermore, there was no bar set for contributions, so the 5.77% average deferral rate had room for improvement.

Given the plan sponsor’s financial limitations, the solution to boosting participation was a plan redesign. Implementing a proactive design feature such as auto enrollment requires employees to actively decide not to participate, overcoming their inertia.

Increasing participation by itself is not a solution for retirement readiness. The deferral rate must be adequate to enable participants to replace a healthy portion of their income in retirement. Pairing automatic escalation with automatic enrollment could steadily increase contribution rates with the goal of eventually doubling the average deferral rate.

Boosting deferral rates can help more employees retire on their own terms and allow highly compensated owners and managers to contribute more to the plan. Remember, most business owners are pleased to help their employees as long as they are helping themselves as well.

Taking the time to fully analyze the plan sponsor’s situation and retirement plan goals goes a long way towards a winning presentation. By avoiding the knee-jerk recommendation to institute matching contributions, the adviser demonstrated that he was listening to the client and was prescribing a cure that the patient could tolerate.

Other recommendations for future consideration could include tactics such as targeting enrollment campaigns to specific employee demographics, simplifying the investment lineup, and educating plan participants on target-date investing. Of course, appropriate recommendations depend upon the specific features and circumstances of the plan and its participants. Plan sponsors should consult with their plans’ own advisers, legal counsel and other experts, prior to making any determinations.

Re-evaluation: One year later, the printer had modified its 401(k) to incorporate both auto enrollment and auto escalation. The results were nothing short of transformational: The percentage of plan participants on track to replace at least 75% of their income by age 67 doubled to 50%.

The redoubled retirement readiness will help the plan sponsor minimize rising costs for salaries and benefits as employees age. A rising average deferral rate will enable the business owner and top managers to increase their deferrals with minimal concern about corrective distributions.

Hygeia would be pleased with the recovery of plan health for the printing plant’s 401(k) plan and the improved retirement readiness of its employees. After all, gods and goddesses everywhere want to retire comfortably, on their own terms.

E. Thomas Foster Jr., Esq. is assistant vice president, strategy and relationships, for MassMutual Retirement Services, a division of Massachusetts Mutual Life Insurance Co., Inc.

 

From Participation to Engagement

Retirement plan participants who receive regular advice from a financial professional are more aggressive and engaged when it comes to pursuing individualized savings targets, a new study shows.

The results of a Natixis Global Asset Management study reveal even those who receive regular financial advice often fall short of self-identified savings targets for retirement, however. On average, 401(k) participants across all age groups are saving about 8.6% of annual salary for retirement. Savings rates are somewhat higher for those with a professional advice relationship, according to the study, but even this group struggles to achieve retirement readiness.

One cause for celebration, Natixis says, is that participation in employer-sponsored retirement plans is substantial. About 90% of all employees with access to workplace retirement programs elect to participate. Natixis cites tax incentives, matching contributions by employers and automatic enrollment as factors underlying high participation rates.

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Another positive point in the research is that contribution rates tend to rise with advice. On average, advised investors put 9.5% of annual salary into a defined contribution (DC) retirement plan, compared with 7.8% by those without advisers. Natixis says advised investors are also more likely to have set an individualized savings target—with more than seven in 10 (74%) advised participants saying they know what their 401(k) balance should be by the time they retire. Just 54% of workers without advisers say the same.

Ed Farrington, an executive vice president of Natixis Global Asset Management, tells PLANADVISER that the mixed study findings show the DC retirement industry has a lot of work to do before it can ensure retirement readiness for most Americans. Advisers and sponsors have a critical role to play in helping participants understand both savings needs and strategies for maximizing readiness, he adds.

“Above all, this research shows that we need to start thinking about how to move beyond participation rates and start building true engagement with DC retirement benefits,” Farrington says. “We know that plan providers have done a great job building powerful tools and account management technologies that make participation easier, but we clearly need more education about why these tools exist and how they can be helpful.”

Indeed, even with the generally encouraging level of participation and savings, many workplace retirement savers aren’t on course to meet their savings targets, Farrington warns. The potential shortfall is especially notable among Baby Boomers, identified in this study as individuals ages 50 to 67. Many in this age group lacked access to retirement plans earlier in their careers, the research shows, and even if they did have access, many Boomers contributed significantly less to their 401(k)s than they do now.

Specifically, the survey found 33% of Boomers have put aside less than $50,000 for retirement. In comparison, 41% of participants in the Millennial or Generation Y group (ages 18 to 33) already have put aside $50,000. Farrington says this is perhaps the most troubling statistic found in the study, especially considering that more than eight in 10 (84%) plan participants across all age groups say their 401(k) account will be their biggest source of retirement income.

“The Baby Boomers with less than $50,000 are going to struggle to retire in the traditional sense,” he explains. “Some say they will delay retirement, others that they will rely on the government or their family members for sources of supplemental income. It’s unclear how they will be able to fill the substantial savings gap.” (See “Baby Boomers Caught in the Middle.”)

But the story is not all bad for Baby Boomers, Farrington adds. On average, Baby Boomers have saved about $262,541 in DC accounts. While this is still only about one-third of the $805,398 Natixis predicts the typical Baby Boomer will need for a lifetime of retirement income, many Boomers will draw at least small amounts of supplementary income from sources like Social Security or defined benefit plan benefits accrued earlier in their careers.

Younger investors are also struggling to stay on target for a successful retirement, Natixis says. Members of Generation X (ages 34 to 49) have saved $206,866 toward their goal of just over $1 million. Millennials average $91,215 in their DC accounts. According to Natixis, Millennials say they’ll need about $822,000 for retirement—a target which may be too low, given their ages and expectations of inflation and increasing health care expenses (see “Personal Accountability in a DC World”).

The good news is that workers say their employers provide a great deal of retirement information and tools. Among the most popular materials available to them are printed education documents, retirement calculators and interactive planning tools. However, relatively few investors make full use of the offerings, Natixis says.

The most popular tool on many 401(k) websites—a retirement income calculator—has been used by only 38% of participants. Likewise, slightly more than half (51%) say their employers offer personalized performance benchmarks, such as displaying a rate of progress toward a retirement savings goal. But only 23% acknowledge using them.

Farrington says these results demonstrate that, without a proper advice relationship, education and tools provided to retirement plan participants may not be leading them to save enough to ensure good outcomes. Part of the reason for the disconnection, Natixis says, is that some investors don’t understand the information put before them. More than four in 10 (43%) say their employer’s materials are difficult to understand. Those working without advisers are more likely to have issues with their employer’s information (49%, compared with 37% of those who do use advisers).

Investors, both with and without an adviser, display substantial uncertainty about investments and investment decisionmaking. In fact, 33% of all participants say they don’t know where their money is being invested. Farrington says this figure cuts across both advised and non-advised participants, “so clearly there is more work ahead for advisers especially.”

More information about the survey results is available on the Natixis website.

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