The media often use the term “retirement readiness” to describe whether retirement plan participants will be properly prepared for retirement at the end of their careers. Both employees and employers have responsibilities they must fulfill in order for employees to reach retirement readiness nirvana.
The attributes listed below have become associated with an employer’s responsibilities in helping participants achieve retirement readiness. There generally are three main categories of employer responsibility: Encouraging employees to participate, helping them manage their accounts and protecting participants from themselves.
Encouraging Employees to Participate
To ensure the participation of as many employees as possible, automatic enrollment in 401k plans has become a plan design standard. Studies have consistently shown that at least 80% of employees who are automatically enrolled will not opt out. This is an effective strategy to fix low plan participation. Every employer should take advantage of it.
Default participant 401k contributions of at least 3%
It’s not enough to auto-enroll employees. In order for them to have a fighting chance at funding their retirements, they have to make contributions. A default 3% contribution rate was an industry standard. However, that is changing.
Many studies have shown that participants need to add at least 15% to their 401k accounts every year they work to achieve retirement readiness. As a result, initial default rates from 4% to 6% are starting to become the norm.
In order to reach the desired 15% in annual 401k account additions each year, participants auto-enrolled at 3% to 6% need to increase their contribution rates as time goes by. Auto-escalation to 6% or 9% in 1% annual increments is becoming more common.
Auto-escalation is the least painful way for employees to gradually increase their contribution rates over time to get where they need to be.
A generous matching contribution
To give participants an incentive to contribute, most companies provide at least a 3% matching contribution. Typically, this contribution is expressed as 50% of the first 6% of participant contributions.
Doing some quick math, if employees need to add 15% per year to their 401k accounts, and employers are providing a 3% contribution, that means employees need to contribute 12%. Many employees and employers feel that 12% in employee contributions is difficult for the majority of employees to achieve.
As a result, a lot of employers have moved to a 6% matching contribution meaning they contribute 40% of the target annual addition leaving employees responsible for the remaining 60%. This means that employees would need to make at least 9% in contributions each year.
Or a stretched matching contribution
With the intent of encouraging participants to contribute more to fund their retirement’s, many employers have moved to stretched matching contributions. For those employers that don’t have the ability to fund a higher level of matching contributions, this is an alternative solution to help participants reach 15% in annual 401k account additions. Following is how a stretched matching contribution works.
Rather than allocating a matching contribution of 50% of the first 6% of participant contributions (a 3% contribution to all participants who contribute at least 6%), an employer decides to allocate a matching contribution of 25% of the first 12% of participant contributions, for example. The company’s matching contribution obligation remains the same — 3%. However, all participants who wish to receive the maximum match now need to contribute more to receive it.
Helping Participants Manage Their Account Balances
A Qualified Default Investment Alternative (QDIA) allows an employer to deposit participant contributions (received without participant direction) into an investment option that will provide a reasonable rate of return over time with a good chance of beating inflation. In order for auto-enrollment to be successful, an employer needs to ensure that a QDIA is available and of high quality.
Most 401k plans use QDIAs that are target date funds. There really are only four or five target date families that make sense to invest in. Make sure you select your target date QDIA from this group.
Participants are going to need help managing their balances. Annual investment education sessions with the option of talking with an expert one-on-one are common.
The investment adviser working with your plan should be able to coordinate annual education sessions and be available to meet with your plan participants one-on-one. Your adviser also should be available to answer participant phone calls or emails on an ongoing basis.
Robust online planning tools
The 401k world is do-it-yourself. In order for participants to reach retirement readiness, they need to have access to a set of online planning tools that are easy to learn and use and comprehensive enough to permit planning, forecasting, risk assessment and investment research.
Protecting Employees From Themselves
Availability of different levels of investment advice
Most recordkeepers now provide what can best be described as robo-advice for plan participants. This is a set of investment recommendations based upon an employee’s age and ability to bear risk. Typically, this sort of advice is shared without charge.
Many recordkeepers also facilitate the offering of an additional layer of investment advice that requires users to pay a fee. For participants who prefer to talk with someone about their plan allocations or contribution amounts, this can lead to greater comfort and a higher level of involvement in their retirement plan.
The greatest value that access to investment advice provides is when markets are crashing. Having an adviser available to keep participants from selling when markets are quickly declining is crucial in helping them achieve retirement readiness.
Elimination of participant loans
Many participants who take plan loans will end up defaulting on them when they unexpectedly lose their job or intentionally take another.
It is nearly impossible for a participant who unexpectedly loses a job to come up with the money necessary to pay back a loan. Participants with plan loans are often surprised to learn when they voluntarily leave an employer for a new job that the outstanding balance of the loan is immediately due and payable. Very few have the money available to pay the loan back.
Nonpayment of an outstanding loan balance at separation from service results in a loan default and is characterized as an early withdrawal subject to taxation and early withdrawal penalties. Generally, these defaulted amounts are removed from a participants retirement account balance permanently.
Emergency or sidecar savings accounts
Hardship withdrawals and defaulted plan loans can block employees’ chances to achieve retirement readiness. Many employees are forced to take these withdrawals as a result of a financial emergency because they have no other savings.
Emergency, or sidecar, savings accounts were legislated to help employees create a savings account that could be used for emergencies instead of their retirement plan savings. These accounts are funded via payroll deductions with after-tax contributions.
Most American workers’ biggest financial problem is that they don’t have any emergency savings. Progressive employers are bolting on emergency savings accounts to their 401k plans.
Replacing hardship withdrawals with hardship loans
The tax impact of taking a hardship withdrawal can be devasting – many times taxes and penalties gobble up nearly 50% of a hardship withdrawal. Steering participants to a hardship loan, rather than a hardship withdrawal, provides hope that the amount needed will find its way back into participant accounts rather than being permanently removed.
You may notice that many of the standards outlined above take the power to manage a 401k account out of participants’ hands. Part of ensuring a successful retirement readiness process is protecting participants from themselves and using participant inertia to benefit participants instead of penalizing them.
How does your plan compare?
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.