For many reasons, including funding challenges and increasing costs, most, if not all, American workers entering the workforce today will not be able to secure their retirement savings from an employer-sponsored, professionally managed pension plan. As many plan sponsors continue to de-risk or terminate their pension plans and opt solely for defined contribution plan-type offerings, such as 401k plans, employees must make decisions concerning plan participation, investments and savings rates for their own plan accounts in order to prepare for their own retirements. Problematically, studies in behavioral finance have shown that it is not always easy for employees to make such decisions and, too many plan choices can paralyze plan participants. Employees may procrastinate regarding enrollment in the plan, fail to appreciate the long-term need for savings versus the short-term need for income, or not understand how to select investment options. As a result, several 401k plan design features have emerged which plan sponsors should consider to assist employees in overcoming their savings adverse behaviors and assist them in achieving retirement security, including:
• Auto-Enrollment- Currently, 401k plans can be designed to assist employees in overcoming savings procrastination by including a basic automatic enrollment feature, an eligible automatic contribution arrangement (EACA) or a qualified automatic contribution arrangement (QACA). Under each method, employees are notified that they will be automatically enrolled in the plan and certain pre-tax deductions will be made from their wages as contributions to the plan unless they opt-out or modify the contribution percentage. EACAs also provide that those who are automatically enrolled can withdraw their contributions within 30 to 90 days of the first contribution. QACAs are designed to automatically pass testing, require an initial automatic contribution of at least 3% of compensation which escalates to 6% of compensation by the fifth year, and require an employer matching or non-elective contribution. Plan sponsors interested in these plan features should review the complete requirements of each method under applicable law, including fiduciary responsibilities associated with their implementation.
• Auto-Escalation-This feature, combined with auto-enrollment, can automatically increase participants’ deferral rates in successive years and avoid long term contributions at low savings rates. QACAs require auto-escalation.
• Target-Date Funds. These investment options may serve as qualified default investments in automatic enrollment plans or as investment menu options which enable participants to select a fund whose portfolios have a mixed asset allocation and are professionally managed to align with their target year of retirement. Many target-date funds become more conservative as the investor nears retirement, although some funds may continue equity investments through the retirement date depending upon their glide path. Thus, they can adjust based on a participant’s time horizon but not necessarily their level of risk tolerance. Prudent selection of target date investment options to be offered under the plan by the plan fiduciaries can provide participants with a viable choice to achieve retirement savings.
• Savings Education—Studies have shown that education regarding the importance of saving for retirement may be even more important than general investment education. Providing employees with information about the importance of savings rates, establishing long-term financial goals, “pay-yourself first” lessons, as well as basic financial and investing concepts, can foster a savings mentality and appreciation of the importance of retirement preparedness. Employers might also consider offering financial wellness programs to assist employees in overcoming overall financial stress and managing their personal finances.
• Simplified Investment Menus. In order for plan fiduciaries to limit their fiduciary liability for losses associated with participant investments in participant-directed plans, Section 404(c) of ERISA has several requirements that must be met, including provision of a broad range of diversified investment options to the participants. However, statistics have shown that too many choices do not serve participants well. Plan fiduciaries should consider offering an investment menu under the plan in the range of 15 prudently selected, diverse and reasonably priced investment options.
• Managed Accounts. Providing participants with a choice to have their accounts professionally managed based on their personal profiles, including savings rate, risk profile, age, and expected date of retirement, can assist them in achieving their retirement goals. Plan fiduciaries must prudently select the investment managers of the managed accounts who would also serve as fiduciaries.
Should the pendulum swing again and usher in a return of the professionally managed, employer-provided defined benefit pension plan, then consideration of these 401k plan-type features may not be as critical. As long as individuals will be responsible for managing their own retirement savings, however, access to employer-sponsored retirement plans with features designed to overcome savings adverse behaviors and promote retirement security will be essential.