Retirement plan sponsors have to conquer a great number of fiduciary and plan design basics when setting up a plan, but they might not think about the many misconceptions that participants have about retirement plans and retirement saving—which could be an impediment.
Two of the biggest misconceptions that keep workers from participating in retirement plans are that they are too complicated and that the worker is too young to care about a milestone decades down the road.
“Some of the very most harmful misconceptions that participants have, have to do with the feeling that retirement plans are so complicated that they cannot make prudent decisions,” says Molly Beer, an executive vice president in the retirement plan consulting practice at Gallagher in Chicago. “The mere idea of using the plan to get themselves to retirement can often feel overwhelming.”
Related to this is the thinking among young participants that retirement is so far away that they don’t need to start saving now, says Christian Mango, president at Financial Fitness for Life, a financial wellness provider, in Winchester, Massachusetts.
“Even $1 grows, and the later you begin planning and saving for retirement, the more difficult it is to save enough,” he says. “Being invested and letting the money generate compound interest is the name of the game.”
While these and other misconceptions, like what deferral rate to choose, can be largely stamped out through automatic enrollment and automatic escalation, advisers say, it is not enough to use auto-features without also providing communication and advisory support. Participants need education and individual financial planning to fully appreciate and make the best use of their plan, experts note.
Besides getting participants into the retirement savings game, automatic features free them up to work with advisers on their immediate- and short-term financial needs.
“This means advisers can focus on individual financial coaching as opposed to general education, which participants may or may not benefit from,” Beer says.
Another potentially confusing feature of retirement plans that precludes people from participating is the vesting schedule, especially when a participant will not receive the employer match for years, notes Erik Daley, managing principal at Multnomah Group in Portland, Oregon.
On top of this, he adds, there is no single agreed-upon calculation for the retirement income projections that retirement plan recordkeepers will be required to begin providing this fall, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act.
“While the intention and purpose of these projections is good, the assumptions going in will greatly diverge and could confuse some participants and give others a false sense of security,” Daley says. “Some participants may even think these projections are a guarantee of income.”
Another misconception, says David Swallow, managing director of consulting relations and retention at TIAA in Tampa, Florida, is that low-cost investing is superior and that it will always lead to higher portfolio balances—and even a larger pot of money at retirement.
“We think low-cost investments should be part of a diversified lineup, but they don’t always translate into better performance,” Swallow says.
Hand-in-hand with this challenge is participants’ pursuit of the current best-performing funds, Daley says. Those funds might look good now, but that doesn’t mean they’re the best option.
On the subject of annuities, Swallow says the retirement plan industry is now coming around to the idea of prompting those who reach retirement to purchase an annuity outside of the plan. Through its many surveys, TIAA has found that 69% or more of employees place guaranteed income as a top retirement goal, Swallow says.
“But if they wait until retirement, they will pay retail prices, and the psychological hurdle of purchasing an annuity at that point will keep them from taking that step,” he explains. “We think sponsors should give participants the opportunity to have lifetime income options in the plan. That gives people financial confidence. Purchasing an in-plan annuity minimizes peoples’ risk and increases their retirement income. That said, participants need to assess what is right for their particular situation.”
Then there is the issue of fees. “A prevalent misconception among participants is the notion that the retirement plan has no fees,” Daley says. On the flip side of this, some participants think they need to go with expensive investment options with advice embedded in, such as managed accounts. “This could lead to the participant being sold a service or a product they don’t need,” he adds.
Adequate deferral rates are also critical, says Michael Montgomery, managing principal at Montgomery Retirement Plan Advisors in Tampa, Florida.
“It is faulty for employees to think that investment returns are more important than what they are putting into the plan,” Montgomery says. “How much they save is just as critical.”
Because many participants mistakenly think the default deferral rate—potentially only 3% or 4%—is an adequate savings rate to achieve retirement security, sponsors and advisers need to educate them that the actual total rate should be 10% to 15% of their salary each year, including any employer contributions.
“Otherwise, a 3% deferral rate is a disservice to participants,” Montgomery says.
Finally, there are those participants who are averse to risk and volatile markets and who avoid equity investing at all costs, says Matthew Eickman, national retirement practice leader at Qualified Plan Advisors in Omaha, Nebraska.
“Given the three major stock market corrections over the past 20 years—the technology bubble bursting, the financial crisis and COVID-19—many younger participants have been invested far too conservatively,” Eickman warns.
According to Daley, most participants, especially near-retirees, need education to understand what they have and what their options are—such as what Social Security may provide them or what health care supplemental insurance they will need besides Medicare. “People age 50 and older will be more receptive to such education,” he adds.
“First and foremost, there is a financial literacy problem in America,” Mango concludes. “We have to tackle the financial literacy problem from a number of angles. Our schools need to mandate financial literacy as part of their curriculum, and employers need to support overall holistic employee well-being. A critical part of that is financial wellness and education.”