401(k) Plans Are Progressing: Ensure Clients Take Full Advantage
401(k) retirement plans have evolved considerably since their inception more than 40 years ago. Not only have investment options become more sophisticated, but plan features have evolved to encourage more employees to increase their 401(k) contributions.
This evolution is critical, as a recent report by the Center for Financial Services Innovation indicates that 42% of American adults aren’t saving for retirement at all. And, according to a GOBankingRates study, 42% of Americans will retire “broke” — meaning they will have $10,000 or less saved for retirement.
For retirement advisors, it is important to understand the features that 401(k) sponsors have added in recent years to ensure that clients are taking full advantage of the benefits. Features that automate enrollment, rebalancing, and escalation of contribution rates make the 401(k) experience easier for employers and employees alike and increase overall plan participation. Here is how they work:
Automatic enrollment. Employees are automatically enrolled in their company’s 401(k) plan after their eligibility date. The plan must give the employee the opportunity to opt out of participating before it makes any deferrals. This feature improves employee participation and helps encourage saving for retirement. According to the Deloitte 2017 Defined Contribution Benchmarking Survey, in recent years there has been increased use of the automatic enrollment feature. The number of plans containing an auto-enrollment feature has increased to 67% in 2017, up from 55% in 2013 / 2014. What is key, as the report explains, is for participants to take full advantage of such a feature.
Automatic rebalancing. After an employee chooses their 401(k) investments, those options are likely to grow at different rates, throwing off the initial allocation. Automatic rebalancing makes adjustments to bring the allocation back in line with what the participant originally desired. As a case example, let’s suggest that a participant’s initial allocation was 20% each to large-cap growth stocks, small-cap growth stocks, international stocks, a target date fund, and bonds. After 12 months, large and small cap stocks have grown, international stocks have declined and the target date and bond funds have grown at smaller rates. Automatic rebalancing would bring each allocation back to 20% of the total. This is useful for participants who may not follow day-to-day investment results, but are confident in their initial allocation.
Automatic contribution escalation. Many new employees begin contributing to a 401(k) plan at a relatively low level. Automatic escalation enables a gradual contribution increase, making it easier to save for retirement. It can happen in two ways: The first is voluntary, where a participant decides when he or she wants to increase contributions. This may be tied to salary increases or to certain ages — for example, an employee can start contributions at 7% of salary and then increase by 2% at ages 35, 40, 45 and 50 until reaching 15% of salary. Or, the plan itself may provide automatic contribution increases of 1% annually to a maximum of 10% of salary. This feature is extremely beneficial as industry experts assert that employees should be saving between 10% and 15% of pay in order to retire comfortably.
Encourage employees to save
Dustin Reding, director of 401(k) and Section 125 Services at Paychex®, explains Paychex added automatic enrollment about four years ago and has over 200,000 participants in plans that offer that feature. In those plans, 79% of eligible employees participate.
“That is a very high participation rate, much higher than the rate in the average 401(k) plan,” he says.
Reding adds that the percentage of employees who opt out of automatic enrollment once notified that deductions will begin is under 5% — a relatively low rate.
“There is a savings crisis in America,” he says, “and automatic enrollment helps an employer do something in the best interest of their workforce — encourage employees to save for retirement.”
According to Reding, depending on plan design, a higher participation rate can also help with compliance testing and improve overall plan health. Additionally, higher participation oftentimes helps higher wage employees contribute more. And in tight labor markets, like today, Reding says greater participation in a company’s 401(k) can help with recruiting and retaining employees.
Time — and 401(k)s — are changing
Later this year, Paychex will also allow participants to set up regular contribution increases. “The 401(k) experience is evolving to keep pace with people’s critical need to save for retirement,” says Reding.
Plan sponsors are adding new features like automatic enrollment, rebalancing, and contribution escalation, as well as making participating in a 401(k) as easy as a few clicks on a mobile phone. With increasing regulatory pressure from states to offer employees simpler ways to save for their own retirement, these changes continue to bring 401(k) plans into the 21st century.