(From 401(k) Specialist, Issue 3, 2016)
401(k) advisors might be surprised to learn they’re more familiar with famous physicist Sir Isaac Newton’s First Law of Motion than they think. Every retirement plan advisor is faced with the ultimate challenge of getting more employees enrolled in the plan. However, Newton’s law of inertia—stating “objects at rest, tend to stay at rest”—reminds us it can be very difficult to get people to take that first step of enrollment.
In traditional 401(k) plan design, employees must take several steps to begin saving: enroll, review investment options, choose a salary deferral rate, select an allocation mix, and more. In order to not save, all they have to do is …well, nothing. It’s obvious which is easier.
Additionally, many employees are overwhelmed at the prospect of deducting money from their paycheck if they are already faced with financial stress in their daily life, such as student loans or credit card debt. The combined effect leaves them unlikely to enroll, and consequently, ill-equipped for their future.
Getting Participants into the Plan
The reality is that no matter how a plan is designed, employees are being steered in some direction. Automation steers them onto a path of saving for their retirement while still giving them the freedom to make their own choices should they decide a different option is best.
If there is any doubt about the impact of automatic enrollment, consider this point. According to the 2014 edition of the Profit Sharing Council of America’s Annual Survey of Profit Sharing and 401(k) Plans, only 5.5 percent of participants who were automatically enrolled in a plan opted out, which is down from 7.2 percent in the prior year.
Some employees may not be thrilled about auto-enrollment plans because they feel their employer is taking action on their behalf. However, it is important to note that employees still have a choice. They can still opt-out of the plan or reduce their contribution amount.
Taking the Next Steps
Enrolling in the plan is just one challenge, but ensuring participants are actually saving enough is another. Many participants do not realize that the contribution rate is the single most important factor to reaching retirement goals, as supported in 2014 research from the Empower Institute.
While investment options and allocation decisions make an impact, the sheer amount aspiring retirees save tends to have the greatest impact on retirement security. Most plans suggest beginning at an automatic contribution rate of 3 percent.
However, most of the time, the math doesn’t add up; this approach does not yield enough savings to set participants up for the retirement they desire. Not to mention, most investors simply forget about their 401(k) and fail to increase their contribution rates over time, which can lead to problems later down the road.
We encourage plan advisors to take a more aggressive approach, which can kick start a retirement savings agenda and set the participant up for financial success. We recommend utilizing an auto-enrollment feature starting employees at a contribution rate of 6 percent of their salary. Further, it is equally important to automatically escalate the employee’s contribution rate by 2 percent each year—although general consensus suggests just one percent.
Doubling these rates may be a tough sell, especially when both the initial contribution rate and the auto-escalation rate are well above the industry standards. However, the approach puts participants on a solid path to retirement.
According to a 2012 study from the Employee Benefit Research Institute comparing initial contribution rates, raising the default contribution rate for auto-enrollment plans to 6 percent from 3 percent increases the chances of a successful retirement for the lowest income quartile to 71.8 percent from 62.1 percent.
For the highest income quartile, increasing the initial contribution rate to 6 percent from 3 percent raises the chances of a successful retirement to 51.9 percent compared to 41.1 percent. The difference in retirement success is certainly notable and the numbers simply cannot overlooked by 401(k) specialists.
For advisors, little is more important than securing a successful retirement for 401(k) participants. When discussing plan options with sponsors, advisors need to consider the benefits of the auto-enrollment features and designs, especially for companies with relatively low participation. These features are a proven and effective means to boost enrollment and overcome the inertia currently plaguing the retirement savings landscape.
Lisa Kottler is senior vice president of retirement services at NFP, a leading insurance broker and consultant. Kottler focuses on building better tools and methodologies so NFP advisers can advance and grow their retirement plan practices.