Retirement Readiness Helped by Plan Design
Retirement readiness is a key area of focus for retirement plan sponsors and advisors. By taking a participant-first approach and “modernizing” today’s defined contribution (DC) plans, plan sponsors and advisors can work together to help improve participants’ retirement readiness across the board.
So says a recent article from BenefitsPro, written by Monika Hubbard, an Institutional Retirement Consultant with Unified Trust Company. According to Ms. Hubbard, the modernization of today’s retirement plans to provide participants with a roadmap for retirement readiness and maximize the inherent tax benefits of DC plans is rooted in four areas:
“1. Plan design strategies: Utilizing automatic enrollment and progressive savings escalators
- A focus on retirement readiness and outcomes: Shifting the plan sponsor oversight focus from fees and funds to meaningful results – participant retirement readiness
- Thinking outside of the retirement box: Embracing other [qualified default investment alternatives] QDIA [options], such as managed account solutions
- Facilitating a better process: Making it EASY for both the participant and plan sponsor”
Ms. Hubbard suggests plan sponsors and advisors should strive to boost retirement readiness by implementing the automatic enrollment and progressive auto-escalation features; or, if the plan already has these design features in place, to review and recommend new features to improve plan engagement and effectiveness. Automatic plan design features have gained popularity to help improve retirement readiness since the passage of the Pension Protection Act of 2006. However, while these features are proven to increase retirement readiness by improving plan participation, average deferral rates, and overall plan performance, the uptake rate has been lagging.
Nonetheless, Ms. Hubbard cites some encouraging data from Vanguard’s 2019 “How America Saves” report, which indicates that retirement readiness is on the rise, thanks to automatic features and increased usage of QDIAs:
- 48% of plans have adopted automatic enrollment — a three-fold increase since year-end 2007.
- Two-thirds of plans with automatic enrollment have also implemented an automatic contribution escalation feature, with a common default increase of 1% annually.
- Ninety-nine percent of all plans with automatic enrollment default participants into a balanced investment strategy.
- Ninety-eight percent of plan sponsors choose a target-date fund as the default investment option.
- Automatic enrollment plans experienced a 93% participation rate among new hires, compared to 47% with voluntary enrollment.
- Eight in 10 participants increase their contribution rates, either automatically or voluntarily.
- Three-quarters of participants remain exclusively invested in the default investment fund.
Moreover, default decisions made by plan sponsors have a positive impact on retirement readiness. More than 50% of plans selected a 4% or higher default rate, compared to just 27% of plans in 2007, Ms. Hubbard noted. In addition, nearly four times the number of plans (23%) chose a default rate of 6% or higher compared to 2007 (6%). Plan sponsors often worry that participants will opt out if the default rate is too high. However, another Vanguard study suggests that this is not the case — the participation rates among employers in that study was around 85%, with initial contribution rates of 2-6%, or somewhere in between.
Ms. Hubbard suggests that plan sponsors can modernize DC plans and improve retirement readiness by breathing new life into their plans’ auto features. Specifically, she offered the following ideas:
- Offer participants the option to contribute to a Roth option as well as a traditional pre-tax plan.
- Conduct a “sweep” of all non-participants into the plan every few years.
- Consider raising your plan’s initial contribution level to 6% if possible.
- Re-evaluate your automatic contribution escalation rate; consider a 2% increase every two years.
- Consider other QDIAs than target-date funds, such as managed accounts.
Retirement readiness research suggests that only around 25% of participants in DC plans are on track for a successful retirement, Ms. Hubbard noted. She opined: To make meaningful change in retirement readiness statistics, plan sponsors and advisors must partner together and take a participant-first approach to plan design and the implementation of automatic features. While a focus on fees, investment options, and fiduciary duties is important, so too is moving the needle in a positive direction on retirement readiness. Bringing your retirement plan into the 21st century by implementing or adjusting your plan design to include auto features that reflect some of the industry’s best practices is one way you can significantly impact your participants’ retirement readiness.
Steff C. Chalk is Executive Director of The Retirement Advisor University, a collaboration with UCLA Anderson School of Management Executive Education. Steff also serves as Executive Director of The Plan Sponsor University and is current faculty of The Retirement Adviser University.