Beyond Auto-Mania: The Future of 401k Plan Design
(This is the fourth and final installment in a series of four articles.)
Previously, we outlined the steps a 401k plan fiduciary can take to avoid a poor plan design. To highlight the impact of just one of these steps, let’s see what the statistics say about the significance of auto-enrollment. The DOL’s website says, “Approximately 30 percent of eligible workers do not participate in their employer’s 401k-type plan. Studies suggest that automatic enrollment plans could reduce this rate to less than 15 percent, significantly increasing retirement savings.” Moreover, according to the March 2013 “Trends in 401k Plans and Retirement Rewards” survey issued by WorldatWork and the American Benefits Institute, “37% of companies with auto enrollment reported participation in the 80%‐89% range, but only 21% of companies without auto enrollment report similar 80%‐89% participation. Further, 36% of those with auto enrollment reported participation in the ‘90% or greater’ range while only 19% without auto enrollment report similarly in the ‘90% or greater’ range.
Of the recent movement to upgrade plan designs, Alicia H. Munnell, the director of the Center for Retirement Research at Boston College and the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management says, “The movement toward auto-enrollment appears to have hit a plateau; the share of plans adopting it has stabilized at around 50 percent.” Indeed, the WorldatWork/American Benefits Institute survey shows “56% of respondents reported their company offers automatic employee enrollment in the 401k” with “An additional 18% said they were considering auto-enrollment.”
Aon Hewitt reported in 2012 that this 56% number has remained “flat since 2009.” Yet, the Society for Human Resource Management says, “small companies consistently have avoided automatic 401k plan features, such as automatic enrollment and contribution escalation. Experts suggest that small companies, with their more personalized approach to benefits and one-on-one interaction between HR and employees, do not need automatic features.”
Robert M. Richter, vice president at SunGard’s Relius in Jacksonville, Florida says, “One of the fastest growing trends is designing plans with automatic contribution agreements. These arrangements do increase coverage. Escalation provisions (deferral rates increase over time) are becoming more popular because they help increase the adequacy of savings. Implementation can be difficult; especially for smaller plan sponsors that do not have all the tools needed to ensure the payroll processing is handled correctly. An error in implementation can result in corrective contributions being made by employers, and this can be a huge deterrent to including these features in a plan.”
The various “autos” – auto-enrollment, auto-escalation, and auto-asset allocation – appear to have encouraged increased savings by 401k plan participants. Robert C. Lawton, President of Lawton Retirement Plan Consultants in Milwaukee, Wisconsin says, “There appears to be a trend to put guard rails on 401k plans to guide participants in the right direction, keep them on track and help them avoid hurting themselves. Auto-enrollment and auto-contribution escalation to guide; Target date funds to help participants stay on track; and, Reduction in loan and withdrawal options and tightening of eligibility to prevent account balance leakage.”
Where do we go beyond this auto-mania? What new developments can we expect to see on the horizon? Alan Hahn, a Partner in the Benefits & Compensation Group at Davis & Gilbert LLP in New York City says, “There’s been a lot of discussion recently among plan sponsors regarding the ‘retirement-readiness’ and the ‘financial wellness’ of their employees. Whether these are just industry buzz-words or this translates into action depends on many factors, including the financial commitment the employer is willing to make to the plan. For those not already doing so, plan fiduciaries should spend more time focusing on participation rates and how to engage employees.”
The industry has certainly seen less talk about evaluating investment performance and more talk about assessing retirement readiness. “Plan success should be measured in terms of how well your plan is able to help participants meet their retirement goals for financial security,” says Richard Rausser, Senior Vice President of Client Services at Pentegra Retirement Services in White Plains, New York. “Real plan effectiveness should be measured in terms of whether participants are on track to succeed. Staying on track is the key.”
While professionals see the need for a more goal-oriented focus, many wonder if plan sponsors see it too. Nathaniel C. Propes, Chief Investment Strategist at Capital Management Advisors in Atlanta, Georgia says, “The plan sponsors that we speak with typically appear at the polar opposites of 401k knowledge. Either they are very knowledgeable about the available design features or their current broker/advisor/rep has not been discussing these changes with them.”
Will the popularity of automated features lull plan sponsors into complacency? And, if that happens, then what? “Plan advisors and/or custodians have to be more involved in the plans,” says Ozeme J. Bonnette, a Financial Coach at Tri-Quest Investment Advisors in Fresno, California and Torrance, California. “They cannot run on autopilot. Advisors and trustees must communicate regularly to make sure the plan is continuing to serve the interests of its participants.”
The emphasis, though, shouldn’t be on the plan sponsor exclusively. Christopher Hobaica, co-founder and principal of HNP Capital LLC in Pittsford, New York says, “With the phasing out of pensions and the cost of benefits increasing dramatically, there has been more of a focus on bolstering the company sponsored retirement plan in order to attract good talent. We have seen everything from safe harbor contributions (versus match) and generous profit sharing contributions to having us meet one on one with participants on a semi-annual basis to help with retirement plan allocations and recommendations. Some Plan Sponsors who are flush with cash have even entertained the idea of adding a cash balance component to their retirement plan.”
Engaging employees means going further than mere generic education. It must be plan specific in order for plan beneficiaries to take the necessary actions that are in their best interests. “A lot of plans only offered the Traditional 401k option and the ROTH 401k option often comes as a surprise to many participants. This is often very attractive to high earners,” says Seth Deitchman, Financial Advisor at Morgan Stanley in Atlanta, Georgia. He adds, “Education and support to employees and the different groups within the organization is a big piece of 401k plans that is not utilized. The usage of the specialists and advisors help to increase savings rates and participation.”
Propes agrees. He says, “First and foremost education is paramount, not only for the plan participants but also for the investment committees and plan sponsors. As new features emerge, the plans that stay on the cutting edge, in our opinion, stand a chance of not only performing better but helping employees save successfully for retirement.”
But there’s a limit to what we can expect from education – at least the way most education is conducted today. Lawton says, “It appears that participants wanted plan designs that favored ‘do it for me’ rather than ‘let me do it myself.’ Most large plans now have participation rates in the 90%+ area. They have increased their non-highly compensated employee deferral percentages significantly. All because of auto-enrollment and auto-contribution escalation. For many years it was thought that employee education was the solution to low participation rates and low deferral percentages. Many plan sponsors were told that all they had to do was give their participants the tools, educate participants on how to use them and get out of the way. That hardly ever worked! In addition, many plan sponsors felt that participants would rebel against auto enrollment and auto escalation. They cringed at making decisions that impacted their employees take home pay without their authorization. Data now shows that the vast majority of participants accept auto enrollment AND auto escalation. It is hard to argue against the success of the ‘do it for me’ auto features. Because of this success, it is likely that 401k plans will continue to become more ‘guided.’ It turns out participants appreciate less choice and more guidance.”
Richter pushes this thought to the edge of the envelope. “This will be viewed by many as heresy,” he says, “but getting rid of participant investment direction altogether could improve plan design. Or maybe only permit it as participants near retirement, which is when they will have more of an interest in ensuring they are able to manage their assets. Studies say participants want the ability to direct the investments of their accounts – they want control. But the reality is only a very small number of participants want that control. The problem is overcoming the investment fiduciary hurdle.”
Indeed, between the trends in legislation and the trends in plan design, we may be seeing the at least partial return to the traditional profit sharing plan. More appropriately, perhaps the direction is towards a hybrid plan design – one part the “one portfolio” profit sharing plan; the other part the mutli-option menu we’ve become used to in the 401k plan. In either case, this bodes well for reducing plan sponsor fiduciary liability. Lawton says, “The auto and guard rail changes seem to create a higher level of fiduciary compliance for the employer since all of these plan design enhancements benefit participants. The new ‘guided’ plan features being implemented either result in higher final participant balances or account balance preservation.”
Finally, what’s prognosticating about the future without dreaming the impossible? Andy Bush, Partner at Horizon Wealth Management in Baton Rouge, Louisiana would like to see regulators “lift discrimination testing and limits – allow people to put in what they wish. If the government is concerned about collecting enough tax from income, maybe limit the amount of pre-tax dollars that you can contribute, but otherwise allow people to save what they wish.”
Bush’s idea may not address plan design exactly, but it does get to the heart of the matter – increasing retirement savings. This reflects the dramatic change in the nature of the discussion. For the longest time, 401k service providers, plan sponsors, and participants spent all their attention on portfolio theory, asset allocation arguments, and investment performance. Today, they’ve all aligned their collective eyes on the ball of retirement savings. There’s a universal understanding that dedicated and disciplined savings is the best way to insure a comfortable retirement.
And, after all, isn’t that what it’s all about?
Interested in learning more about important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada. He will be speaking at CFDD ’14 on the subject of “Using Proven Psychological Techniques to Motivate Plan Sponsors & Participants to Implement Your Recommendations.” The session will feature a unique but highly effective presentation style and feature tools mentioned in his new book Hey! What’s My Number? – The One Thing Every Retirement Investor Wants and Needs to Know!