As defined benefit (DB) plans shrink in number and the future of Social Security benefits dips further into uncertainty, defined contribution (DC) plans and individual retirement accounts (IRAs) are becoming the primary tools driving America’s retirement security.
However, many Americans are behind on retirement readiness. More than half (52%) of households are at risk of not being able to maintain their standard of living in retirement, according to a recent study by Prudential and the Center for Retirement Research at Boston College (CRR).
And with a heightened scrutiny on fees and fiduciary responsibility, it’s becoming increasingly important for plan sponsors to ensure their participants’ retirement readiness and maintain a healthy plan.
Sean McLaughlin, senior vice president, head of client relations and business development, Prudential Retirement, tells PLANSPONSOR that a major component to any healthy plan is “the right plan design for your participants.”
Features such as auto-enrollment have been among the biggest drivers of higher participation, according to Wells Fargo’s study “Driving Plan Health 2016.” Still, the Plan Sponsor Council of America (PSCA) found that the most common auto-enrollment salary deferral rate is 3% of pay. “We recommend closer to 6%,” says McLaughlin.
While some sponsors may fear this would reduce participation rates, volumes of evidence suggests otherwise.
Wells Fargo’s data indicates that plans which have auto-enrolled participants at a deferral rate of 6% averaged 87% participation rates. The figure is 83% for those that auto-enrolled at 3%. The firm also notes that opt-out rates “do not vary substantially from lower to higher default deferral rates,” and that plans with lower default deferral rates naturally have overall lower average deferral rates.
NEXT: Plan design and plan health
Furthermore, the PSCA found only 65% of plans with auto-enrollment utilize auto-escalation. McLaughlin suggests auto-escalation of 1% annually up to 10%, “or more if the employee population can save more.”
Auto features are so important to a healthy plan because otherwise a whole lot of people will never take the necessary action to enroll themselves, even if they like the idea of saving, warns Zane Dalal, executive vice president at Benefit Programs Administration (BPA). “Let’s say you get into a 401(k) in your 20s, and by the time you’re ready to retire, you can have $1 million. If you were not clear about this in your 20s and decide to start contributing in your 30s, you’d only have about $630,000. It’s a huge disadvantage.”
McLaughlin suggests plan sponsors “auto-enroll until people give up and they’re in the plan. Do it on an annual basis, reenrolling the entire eligible population.”
A company match can also go a long way, even without auto-enrollment. The Wells Fargo’s data indicates that for plans without auto-enrollment, the average participation rates were higher for those with the larger matches. Plans with matches up to 3% averaged 48.7% participation. Plans with matches between 6% and 9% averaged 64.6% participation.
But regardless of how much money employees defer, what matters most is where that money goes.
NEXT: choosing the right investments
Alleged excessive fees have been central to plenty of the current litigation surrounding the DC space. Thus, to have a healthy plan, sponsors have to maintain a cautious eye when selecting investments for their qualified default invest alternatives (QDIAs), and understand the different share classes available across the entire core menu.
This decision can and should rely heavily on employee demographics. Target-date funds (TDFs) and managed accounts offer the advantage of letting participants hand over investment management to professionals. And while TDFs currently dominate the DC space, they can vary widely based on provider.
Prudential’s paper notes that “sponsors should consider how well a target-date fund’s characteristics align with the demographics of the plan. The glide path design should address the right risks at the right time—target date funds need to be aggressive enough to address longevity challenges while not over-exposing participants to market risk near retirement.”
And while basic demographics tell a sponsor a lot about participants’ risk tolerance, other factors should also be used to dig deeper. The job itself can play a significant role in how an employee saves.
“Different industries have different expected return and profit levels, which makes more or less money available to invest in a retirement program for employees,” says McLaughlin. “Industry matters a lot, and it has to be factored into plan design. Sponsors need to speak specifically with advisers, providers and stakeholders to discuss their needs as an organization and where they are in their lifecycle, whether it be a start up with limited cash or a large and very successful firm.”
This, along with fund performance and costs, are some of the main points to consider when selecting a fund lineup. Choosing the right options could not only attract and retain the best talent, but also provide the right amount of turnover.
NEXT: Helping participants retire on time
“One of the challenges that has been much more common since the financial crisis has been workers not retiring at a ‘normal’ retirement age, and sticking out longer than employers may have planned,” explains McLaughlin. Research sponsored by Prudential notes that a one-year delay in retirement may result in incremental workforce costs of 1% to 1.5% annually.
McLaughlin suggests that one way to address this issue, along with the fear among participants of outliving their assets, is to incorporate an in-plan guaranteed lifetime income (GLI) product.
He alludes that even if a participant has enough assets to feel retirement ready by the time he reaches that milestone, the drawdown phase poses another challenge. “How does he take that money as income? Most folks don’t have expertise around that. So, having an in-plan income option is really helpful.”
Prudential also notes that GLI may serve as a backdrop for participants in the event that a severe market downturn impedes retirement readiness. One of the firm’s recent surveys finds that 53% of financial executives believe participants will engage in less risky behavior—like getting out of investments at the wrong time—if they are invested in some kind of GLI product.
“The biggest mistake you can make is jumping in and out of the market,” says BPA’s Dalal. “It’s the biggest killer in the investment world.”
Choosing the best fund lineup would help plan sponsors meet their fiduciary responsibilities and comply with various regulators in the DC space. In this realm, it’s also important to leverage support from all parties involved in the plan.
“Consultative regulatory services can help plan sponsors navigate the complexity of having a DC plan,” McLaughlin concludes. “They can look at plan documents, plan design and all of the different elements that tie back to regulation before making a set of recommendations.”
But even solid plan design and a strong investment lineup will fail to reach the plans’ full potential if participants aren’t utilizing the plan properly. Education is key to driving engagement. Many tools can boost engagement and help participants think of retirement as a piece to overall financial wellness. And these can be integrated with the existing benefits package to control costs.
The “Driving Plan Health – 2016” report can be found at WellsFargoMedia.com.
“The Power of Plan Wellness” document can be found at Prudential.com.