Building A Better 401(K) – Part One
A blog by Richard Rausser, CPC, QPA, QKA, Senior Vice President – September 16, 2014
To paraphrase Mark Twain, reports of the death of the 401(k) are greatly exaggerated. In fact, they’re not even true.
Google “401(k) gamble” and you will find seemingly endless citations of an April 2013 report on PBS’s Frontline entitled “The Retirement Gamble,” whose ripples unfortunately continue to be felt. The episode cites high costs, poor investment guidance and low participation rates as evidence that the 401(k) plan is a “failed experiment” that has made saving for retirement a “bewildering and frightening challenge” – and postulates that the program should be scrapped.
Retirement savings can indeed be bewildering – and, perhaps, frightening for some – but to suggest that it’s outlived its usefulness is frankly absurd.
Last year, we decided that we needed to make the 401(k) more successful and to get participants to focus on achieving that success by accumulating enough retirement assets to ensure a sufficient income for their golden years. What we came up with is the new Pentegra SmartPath™, an in-depth brochure that features a detailed series of progressive plan design metrics crafted in a way to best ensure successful retirement outcomes for both companies and their participants.
The design we are advising is centered around automation. Automatic enrollment in – and subsequent automatic escalation of employees’ contributions to – a company’s 401(k) is a benefit to employee and employer alike.
As a rule, we believe that saving 10 percent of one’s salary is a crucial element of any retirement plan. New hires are typically presented with a plan that sets aside 3 percent of salary, usually with the company matching that contribution, and increasing by one percentage point a year up to 6 percent.
We recommend automatic enrollment starting at 6 percent, which obviously allows for greater savings. Why start at 6 percent? We find that when people sign up voluntarily, they usually opt for something in the 5-7 percent range to begin with. Why, then, start at 3 percent? That’s selling your employees short.
While 6 percent doubles the cost to the 401(k) provider, we believe that in the long run such a practice will actually save them money. Many people join a given company based at least in part on its retirement plan; providing a demonstrably stronger one than your competitors will both attract and retain talent, giving them some peace of mind about their retirement and, overall, improving morale.
With automatic escalation each year of 1 percent, employees will attain that 10 percent within a shorter time span than previously … and if the employer matches those contributions, an employee could end up putting 13-14 percent of his salary into his 401(k). The positives speak for themselves.
Automatic enrollment and escalation also addresses most employees’ concerns about their retirement savings – which, especially with younger people just joining the workforce – often means “not at all.” The “set it and forget it” model arises in a number of ways: Inexperience at investing their money, uncertainty as to how to prepare for retirement, or – as the term itself indicates – simple forgetfulness. But never managing or monitoring one’s retirement funds is a mistake; automatic escalation can help in this area.
Traditionally employers have taken a “tell us what you want to do and how to invest your money” approach. That’s fine if a given employee is a financial whiz, but not much help to the lion’s share who are not. Most plan participants do not want to teach themselves the ins and outs of the 19 investment options that are typically offered by a defined contribution plan. Instead, clarity of investment choices and ease of use should take precedence over the often-erroneous belief that “the more, the merrier.”
Of course, it’s also not true that “one size fits all” when it comes to retirement funds. Clearly delineating the pros and cons of target date funds, stable value funds of various cap size – in other words, diversity – is of critical importance.
Ideally, a plan’s Qualified Default Investment Alternative (QDIA) should be a single fund investment solution that is well diversified among the various asset classes. Such an approach offers participants a means of keeping their investment strategy simple but sophisticated. Target date funds, asset allocation funds, and model portfolios are all fine examples of a workable, easy to understand QDIA solution.
As for the trends in automation: Over 50 percent of large companies offer auto-escalation, while smaller companies are in the 10-12 percent range. Why the gap? Typically management at smaller companies tend towards a hands-off approach when it comes to “getting too personal” with employees. Also, their older employees tend to already “get it” when it comes to retirement savings. But, again, those companies are doing themselves a disservice, as those older employees retire and the younger ones notice what’s happening at other companies vis a vis 401(k)s.
And as for that fear of “automation” that’s arisen from watching too many sci-fi movies: You always have the opportunity to opt out of an automatic escalation, or to decrease (or, hopefully, in increase) your contribution to your 401(k).
Auto features are here to stay; within three to five years, those features will be commonplace. Why not take advantage of them now?
In a second blog, I will discuss further features of the Pentegra SmartPath™.
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