Plan Design to Improve Retirement Readiness By: Gabriel PotterMBA, AIFA®

Not so long ago, an American worker could reasonably expect a steady Social Security check, a pension, and whatever savings they had accumulated to support their retirement. With pensions losing popularity and projected cuts to Social Security, employees in the future will have to rely a lot more heavily on their own retirement savings, typically earned through a 401(k) or similar program. These defined-contribution programs move the central burden of retirement planning back towards the employee by empowering them to select their own funds, set their own goals, establish their own risk tolerance, and so on. However, the evidence demonstrates employees do not use these programs to their full advantage. The good news is plan sponsors and employers have been given tools (and safe-harbor protection, courtesy of the Pension Protection Act) to make some smart plan design choices. There are plan design features which can counteract several common complaints and ensure employees are getting the most out of their retirement plan.

Complaint #1: “I don’t know which fund to pick.”
Most employees are not financial professionals, and the vast array of investment options in a retirement plan can be intimidating. Many employees are understandably apathetic about making additional time commitments simply to understand the options for a distant retirement. Conversely, employees are no better served if they do decide to enroll in their retirement plan without understanding the options. 

Employers who want to make life simpler for their employees may be well served by adding a Qualified Default Investment Alternative, or QDIA, to their plan. By default, an employee is automatically enrolled in this investment, and it is designed to be appropriate for meeting workers’ long-term retirement savings needs. Practically speaking, a QDIA usually comes in 2 forms: a balanced fund with both stocks and bonds, or a target-date retirement fund which automatically increases the amount of fixed income as a retiree gets closer to retirement.

Complaint #2: “I don’t know if I’m saving enough.”
If we rephrase this complaint as a question “Am I saving enough to retire?” the regrettable answer for most American workers is “No, you’re not.” Consulting firms and investment managers have differing targets for how much “enough” is. For example, Aon Hewitt recommends accumulating eleven times your personal income by retirement at age 65. Another popular rule of thumb is the 4% rate (i.e. if you have $1 million saved, you can withdraw $40,000 each year safely). One thing everyone agrees upon is Americans, in aggregate, are not saving enough to fund retirement.

“Employees are overwhelmed and favor the simplicity of automatic features”
Employers who want to encourage their employees to participate in the retirement plan can use an auto-enroll feature which places employees, by default, into the retirement plan. Similarly, employers can also implement an auto-escalate feature which automatically increases the percentage of retirement savings contributions annually, up to a pre-set maximum (e.g. 15% of salary).

The auto-enroll and auto-escalate features cannot guarantee employees are saving enough. After all, employees can opt-out of the plan. The best solution is for an employee to actively engage with their participant education program or meet with a financial advisor. However, recent studies suggest these plan features are increasingly popular with employers and their implementation is having a positive, measurable difference in retirement readiness for employees. 

Complaint #3: “Am I getting the most I can out of this?”
An attractive retirement plan is a key element for employers trying to attract and retain key employees. Many employers go beyond plan design improvements, and offer tangible incentives for employees who participate in the retirement plan. Specifically, many employers offer a company match on employee contributions in the retirement plan. 

While a company match policy is a benefit, not all match policies are equal. Obviously, increasing the company match (say, from 5% to 7% of annual salary) adds a direct benefit. Less obvious is the type of match: employers may select automatic matching or discretionary matching, which depends upon the profitability of the company and the decision of an investment committee. It is essential for discretionary match policies to be made public sufficiently early so employees can be informed and encouraged to participate in the retirement plan. Clarity on these decisions also ensures employees are fully leveraging the benefits of the retirement plan.

Promoting better outcomes
The best aspect of these plan design improvements is they are automatic. In other words, utilizing these features requires the minimum commitment of time. It may, in fact, take more time for an engaged employee to tailor their contribution levels & investment allocation to their specific needs (or to opt-out), but an engaged employee would have had to devote time to retirement planning anyway. In this case, the only additional cost in time spent opting out is borne by unengaged employees who did not need to participate in the retirement plan — a rarity in modern America. However, most employees are overwhelmed and favor the simplicity of automatic features, so the overall time savings is often worth the modest inconvenience to the minority of employees who require no retirement savings. 

Collectively, these features act as guiderails for employees, encouraging them towards better outcomes.

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Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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