Four Ways to Increase Employee Retirement Contributions
As a retirement plan sponsor, you want your employees to save the most they can in order to reach their maximum retirement potential. A significant amount of research says that you can improve both employee participation and their saving rates. Here are four ways you can help your employees start building a confident retirement:
- Boost employee participation with automatic enrollment. Choosing to automatically enroll all new employees in your retirement plan can dramatically improve your participation rates. According to the Center for Retirement Research (CRR) at Boston College, in one study of automatic enrollment, participation increased by 50 percent, with the largest gains among younger and lower-paid employees.1 While auto enrolled employees are allowed to opt out of the retirement plan, most generally stay enrolled.
- Set the initial default contribution rate higher. Many companies who use auto enrollment set their default contribution rate relatively low at 3 percent, according to the CRR, which is lower than the typical employer match rate of 6 percent. Workers who might have contributed more to their savings passively accept the lower default rate, which means they’re sacrificing employer matching funds along with saving less of their own pay.
- Adopt auto escalation. Plans that use auto escalation automatically increase their participants’ contribution rate every year, typically by 1 percent. Over time, that can significantly improve savings rates among workers. The CRR cites a 2013 study of Danish workers where the majority of workers who experienced automatic increases simply accepted them, and savings rates dramatically increased.
- Automate investment decisions with target date investment products. Investing is complicated, and many employees don’t want to take the time to learn how to manage their portfolios. Target date strategies automatically adjust an employee’s investment allocations over time, shifting them to a more conservative asset mix as the target date (typically retirement) approaches. The ease of use of target date funds means their popularity is increasing. The CRR notes that in 2014, nearly 20 percent of all 401(k) assets were in target date funds, and about half of plan participants used target date funds.2
How Many Investment Options Should You Offer?
Many plan sponsors struggle with deciding how many investment options to offer in their retirement plans. While people generally like to have lots of options when making other decisions, having too many plan options can potentially lead to poor investment decisions by plan participants. In addition, increasing plan options can also increase plan costs, as well as the administrative paperwork associated with the plan.
In a study on retirement plan options, researchers concluded that it is possible to present plan participants with too many options.1 The researchers began by offering people selections of jams and chocolates. Some were offered a wide variety, while others received less choices. The wide variety of jams attracted more attention from people, but more people purchased jams when offered limited choices. When sampling chocolates, people enjoyed choosing from the larger selection more, but also were more dissatisfied with the choices. Those who sampled from a smaller selection were more satisfied and more likely to buy chocolates again. In other words, as the number of options increased, people became more concerned by the possibility of making the “wrong” choice–they became uncertain that they had made the best choice possible.
Chocolates and jams aren’t very big decisions, but the researchers found that these same behaviors carried over to retirement plans. They examined participation rates for 647 plans offered by the Vanguard Group, a large investment management company, covering more than 900,000 participants. They found that as plans increased the number of options they offered, employee participation decreased. In fact, for every 10 options added to the plan, participation dropped by 1.5-2 percent. Plans offering fewer than 10 options had significantly higher employee participation rates.
In addition, more plan options can increase costs both for participants, in the form of fees, and for plan sponsors, who may face additional administrative charges from third party administrators for additional options. Further, auditing and other costs may increase, since the number of options could increase the time necessary to conduct audits.
It’s important to balance choice overload against the requirements of ERISA Section 404(c) which requires plan sponsors to have at least three diversified investment options with different risk and return characteristics.
Hey Joel! – Answers from a recovering former practicing ERISA attorney
Welcome to Hey Joel! This forum answers plan sponsor questions from all over the country by our in-house former practicing ERISA attorney.
What’s the appropriate number of members and positions for a retirement plan committee?
—Plannin’ in Pennsylvania
There is no specific guidance on the appropriate number of committee members. It’s important to have committee members who can contribute to the topics to be focused on. When there is one committee, as opposed to separate committees (for investments, plan design, employee communications, etc.) perhaps a CEO and/or CFO, an administrative executive and a participant communications representative would be appropriate committee members.
Ideally, these would be people who want to be on the committee to make a contribution to plan success and who are willing to accept fiduciary responsibilities, not the least of which is personal financial liability in event of a fiduciary breach. (Our Fiduciary Fitness Program (FFP) is designed to substantially mitigate this liability if followed appropriately.)
You can also have, as a regular or a non-voting member (guest with no intent as fiduciary), someone who can represent an employee base.
Most importantly, when setting up a committee, is to determine who the “named fiduciary” for the plan is. The named fiduciary will be identified in the plan document and this person or entity is the primary fiduciary for the plan. Note, if the named fiduciary is listed as “the Company” this is interpreted to mean the board of directors (if a C corporation or managing partners, if a partnership). The named fiduciary is expected to be the entity who has the authority to decide to have a retirement plan. The named fiduciary can delegate the majority of their fiduciary duties to co-fiduciaries (e.g., a retirement plan steering committee). Typically they would be anxious to do so as they likely would not want to be responsible for day-to-day management of the plan. The Committee Charter and ancillary paperwork (in our FFP) is designed expressly for this purpose.
The Committee Planner Extraordinaire,
Participant Corner: Ten Reasons to Roll Into Your Employer’s Plan Versus an IRA
This month’s employee memo informs participants about the benefits of joining their employer’s plan versus an IRA. Download the memo from your Fiduciary Briefcase at fiduciarybriefcase.com and distribute to your participants. Please see an excerpt below.
Do you have retirement plan assets with a former employer’s plan that you’re not sure what to do with? Review the pros and cons of consolidating into your current employer’s retirement plan versus an individual retirement account (IRA).
- Performance results may differ substantially.
As an institutional buyer, a retirement (401(k), 403(b), 457, etc.) plan may be eligible for lower cost versions of most mutual funds. Cost savings with institutional share classes can be considerable and can have significant impact on long-term asset accumulation, which benefits you.
One recent study by the Center for Retirement Research indicated that the average return retirement plan participants experienced was nearly 41 percent greater than other investors. Share class savings likely contributed to this result.
- The IRA rollover balance may be too small to meet minimum investment requirements.
Many of the low expense mutual fund share classes available to investors outside of retirement plans have minimum investment requirements in excess of $100,000. Some are $1 million or more. As a result, the average retirement plan participant who rolls a balance into an IRA may not have access to certain investments and/or will often end up investing in one of the more expensive retail share classes.
- IRA investment advisors may not be fiduciaries.
In a 401(k) or 403(b) plan (and even many 457 plans), both the employer and the plan’s investment advisor may be required to be a fiduciary. This means that investment decisions they make must be in the best interests of plan participants. This is the golden rule of fiduciary behavior and if not explicitly followed can lead to heavy economic impact to those organizations.
A non-fiduciary IRA broker or advisor is not necessarily required under law to act in the client’s best interests, and as a result, there is the possibility that their recommendations may be somewhat self-serving.
- Stable value funds are not available.
While money market funds are available to IRA investors, they do not have access to stable value funds or some guaranteed products that are only available in qualified plans. Historically money market fund yields have often been below that of stable value or guaranteed interest fund rates.
- IRAs typically apply transaction fees.
Many IRA providers require buy/sell transaction fees on purchases and sales. Retirement plans typically have no such transaction costs.
- Qualified retirement plans (like 401(k), 403(b), and 457) offer greater protection of assets against creditors.
Retirement plan account balances are shielded from attachment by creditors if bankruptcy is declared. In addition, retirement balances typically cannot be included in judgments.
- Loans are not available in IRAs.
Loans from an IRA are not allowed by law, unlike many qualified retirement plans which may allow for loans. Although we do not generally recommend you take loans from your retirement plan, as they may hinder savings potential, some individuals prefer having such an option in the event they run into a financial emergency. Also, as a loan is repaid through payroll deduction, participants pay themselves interest at a reasonable rate.
- Retirement plan consolidation is simple and convenient.
It is easier and more convenient for you to manage your retirement plan nest egg if it is all in the same plan rather than maintaining multiple accounts with previous employers or among multiple plans and IRAs.
- Retirement savings via payroll deductions are convenient and consistent.
The convenience of payroll deductions is very helpful for consistent savings and achieving the benefit of dollar cost averaging.
- For present retirement savings strategies, retirement plans can provide greater savings than IRAs.
The law allows you to make a substantially larger contribution to many retirement plans than you can save with an IRA.
Although personal circumstances may vary, it may be a good idea for you to rollover your balance in a former employer’s retirement plan into your current employer’s plan rather than an IRA. Your savings potential will not be as limited as with an IRA.