I find that many executives are unaware of the options to leverage retirement plan design to improve retirement outcomes. Retirement plan design may include things like:
- Leveraging plan features
- Promoting enrollment
- Structuring the match to incentivize increased savings,
- Using defaults to promote increased savings
- Facilitating wiser investment decisions of your employees
- Cutting corporate taxes
- Allocating higher profit sharing dollars to highly compensated employees,
- Improving investment returns by shifting who pays plan expenses
- Providing, personalized advice for participants to manage expectations and emotions
This blog focuses on leveraging plan features. As steward of a retirement plan your real goal is to improve retirement outcomes, not simply bless an investment menu. Many people would like to retire on somewhere between 70 and 80% of their final paycheck. That paycheck needs to grow to maintain standard of living as the cost of living increases. Benefitting from the potential $24,000 maximum tax deferred savings in 2014 from a 401(k) and ERISA 403(b) starts with participation.
Promoting employee participation through retirement plan design
Is your participation rate 100%? Is at least 90%? If not, read this section.
You can’t enjoy the tax-deferred savings without participating. So how can you motivate your nonparticipants? One of the ways is to automatically enroll them in your retirement plan. You may have concerns regarding this automatic feature. If you do, consider that without participating you may be creating a future problem for yourself. If your employee enjoys working for you and never starts participating they will likely end up costing you money in the form of higher absentee, lost productivity and increased healthcare costs.
Consider organ donation. “Researchers from the University of Nottingham, University of Stirling and Northumbria University in the UK analyzed the organ donation systems of 48 countries for a period of 13 years – 23 using an opt-in system and 25 using an opt-out system. With an opt-in system, people have to actively sign up to a register to donate their organs after death. In opt-out systems, organ donation will occur automatically unless a specific request is made before death for organs not to be taken. They found that countries using opt-out systems of organ donation had higher total numbers of kidneys donated – the organ that the majority of people on organ transplant lists are waiting for. Opt-out systems also had the greater overall number of organ transplants. “People may not act for numerous reasons, including loss aversion, effort, and believing that the policy makers have made the ‘right’ decision and one that they believe in.”1
Promoting employee savings through retirement plan design
Are your employees saving 10% or more? If not, continue reading.
Unified Trust research uncovered that savings is 45 times more important than the rate of return in accumulating your balance. Often savings are anchored on how much the company is willing to spend, the loss of “free money” from the company match. Why not change the match formula to require employees to save more to get the match so they will have to save more?
You may be concerned that this might affect your compliance testing. If you are, this effort should be supported by a communication and advice program to personalize the negative effect of not saving enough. For example, if they had to save 7% on their own in order to get your 3% match if that. Then they’re actually achieving the 10% savings rate that some may need.
Have your employees had a retirement gap analysis done for them by a CERTIFIED FINANCIAL PLANNER™ professional? This exercise will personalize how much they need to save. There are web-based calculators that can help but what are their assumptions? How do they address the employee’s feelings of missing out on life today? Most of us hate the idea of giving up spending on something we want today for a less tangible spend in the future.
You may also want to employ features such as starting them off at a higher deferral rate, say 6% and bump that up by 1% or so every year. If you give them a 3% raise, they could give 1% to retirement and keep 2% for living today. This is known as automatic escalation of savings. I believe this should be supported by a personalized advice program. Advice is different than education in that the advisors offering advice are putting skin in the game by acting in the best interest of the participant aka fiduciary. Plan features are more like using the Air Force to get the enemy on their heals. An advice program is akin to bringing in the Army to go door-to-door to secure the land.
Retirement plan design and improving investment risk and return
Are your employees getting the returns of your plan’s investment benchmarks?
Most employees have no background in investing. Do they have degrees in Finance and Economics or have designation such as a Chartered Financial Analyst or CERTIFIED FINANCIAL PLANNER™ professional? Why not leverage the knowledge of these individuals and building portfolios. In fact portfolio building is an even different animal than simply managing a single asset class investment.
You should choose a default investment that aligns with the demographics of your firm. While target date strategies are very popular, they likely fail an employee who is 50 years old and has no savings and is defaulted into an investment assuming they will retire in five years. Do you know the assumptions of the target date choices you use or may be considering? What is the savings rate assumption? You can read our takes on qualified default investment options here.
Improving investment risk/return with retirement plan design
Are your employees achieving the returns of your plan investment benchmark for stocks and bonds? Do you have evidence that they are well diversified?
Most employees have no background and investing. Most people do not work in financial services and did not have degrees in finance, economics. Practitioners can do further work and get designation such as a chartered financial analyst or certified financial planner. Why not leverage the knowledge of these individuals and building portfolios. In fact portfolio building is an even different animal than simply managing a single asset class investment. You may be familiar with the asset class model of MorningStar.
You should choose a default investment that aligns with the demographics of your firm. While target date strategies are very popular, they likely fail an employee who is 60 years old and has no savings and is defaulted into an investment assuming they will retire in five years. This person likely needs intervention by an investment advisor. Your base may be primarily young 20s where a target date strategies may be appropriate. However without proper saving this target date strategy will fill them in their attempt to grow their balance. Do you know the assumptions based upon the target date choices that may have been presented to you? If it has an investment return assumption, are your employees aware of that savings assumption?
You can see there are several factors that can help your people and help you help them pursue better retirement out outcomes to plan design. We will tackle more issues as we expand on the many areas of plan design and future blogs.
1 Medical News Today, Organ donation: is an opt-in or opt-out system better?, Wednesday 24 September 2014
For Plan Sponsor Use Only – Not for Use with Participants or the General Public This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.