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.”)
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.