Many individuals didn’t have a choice but to lower their defined contribution (DC) plan savings rates, stop contributing or take loans or withdrawals out of their plans because of the economic impact of the pandemic, noted Dr. Shlomo Benartzi, professor emeritus at the University of California, Los Angeles (UCLA) Anderson School of Management and senior academic adviser at Voya Financial, during a Voya podcast.
The podcast, “Plan Designs During Challenging Times,” hosted by Bill Harmon, chief client officer, and Heather Lavallee, CEO of wealth solutions at Voya, addressed what employers can do to help participants get back on track with their retirement savings after events like the pandemic or economic recessions.
Benartzi said thinking about how legislation to encourage more people to save for retirement was passed shortly before the pandemic, but when the pandemic hit America, legislation was passed to make it easier for people to take money out of their retirement plans, shows that there is a need to help individuals plan for the long-term as well as tackle issues along the way.
At the point when an individual is struggling and considers lowering or stopping his retirement savings is a good time for plan sponsors to capitalize on the behavioral economics theory of present bias—where individuals focus on the present benefits of something rather than on the future, said Benartzi. Plan sponsors can offer these employees a path back to savings, he said.
“Plan sponsors can say something like, ‘We understand you have to stop saving today, but how about we set it up so you start saving again at the same rate a year from now, and we’ll set you up for automatic escalation,’” Benartzi said. “That can be an extremely effective way to address both the present need to stop contributions or take a loan from the plan and the future need to get savings back on track.”
Benartzi took some time to talk about default savings rates, saying the industry standard of 3% that many plan sponsors adopted after the Pension Protection Act (PPA) was passed in 2006 is “way too little and won’t get people to the finish line, while creating an illusion of safety because people think if the employer set it up that way, it must be the right thing.”
He noted that years after the passage of the PPA, a paper suggested plan sponsors could push the default savings rate up to 6% and employees wouldn’t opt out, “That tends to work best for people who aren’t inclined to save,” Benartzi said. “Very often it lifts the savings rates of minorities and other groups who don’t save much. It works to close gaps in savings.”
Benartzi said he was among researchers who did a study pushing savings rates up to 6%, 8%, 10% and 11%. The study found that as rates were pushed higher, not only did employees not opt out of the plan, but many engaged with the plan and if they felt the savings rate was too high, they lowered it themselves. In addition, Benartzi said, the study found 7% worked better than 6%, and it really worked well for people who were thinking they would save 5%. “If it was suggested they save 7%, it actually pushed them to do more,” he said.
“The very important take away for plan sponsors is that when you set the default don’t be too conservative. It’s ok to be aggressive,” Benartzi said. “Employees won’t opt out, but they’ll adjust the rate lower if they need to. So, there’s not much downside to suggesting they save more.”
He added that he thinks in the future, default savings rates will be more personalized.
Re-enrollment and Stretch Match Can Help in Tough Times
Benartzi said re-enrollment has a really important role during the pandemic to help people build wealth.
As background, he noted that some plan sponsors think it is too aggressive to keep re-enrolling employees into their DC plans periodically. However, globally it is actually a common practice. In the UK for example, employers have to re-enroll every employee every three years, Benartzi noted.
“The data I’ve seen from other countries shows that among employees who opted out of one re-enrollment, about half forgot they opted out and would like to be in the plan, so they stayed in the plan the second time they were re-enrolled,” he said.
Benartzi said people have been shaken by pandemic, making it the best possible time to think about resetting employees back into the plan. One caveat he noted is that plan sponsors should make opting out easy. “We are not in the business of tricking people to save if they don’t want to, so keep in mind that opting out should be easy,” he said. “And as long as it is, I think re-enrollment is the No. 1 action item plan sponsors should take to get employees back on track.”
Implementing a stretch match formula is also very timely given the pandemic, Benartzi said. It helps motivate employees to save more and can also defer matching costs to the future, to help struggling employers.
He noted that employees in general are not very sensitive to the match rate; there are plans with dramatic variations in rate from 25% to 100%, and employees don’t react to that. Benartzi said he thinks that is in part because people who are not in the retirement plan business don’t understand what a good match rate is. However, people are sensitive to the savings cap on the match, as most don’t want to leave free money on the table. “That’s why a stretch match works to help employees save more,” he said.
The way a stretch match can help struggling employers, Benartzi explained, is that if it is implemented during the pandemic or during a recession, not everyone will bump up their savings to the cap. “It might take a couple of years for employees to react, which actually helps shift match costs from now to 2023 or later,” he said. “So, I think now is a great time to rethink match formulas.”
Benartzi added that plan sponsors need to consider that a stretch match formula works well with auto escalation, because lower-income employees can’t save up to the match cap, but auto escalation can help them get to it. “When employers design a plan, they have to think about the different components of the puzzle and how they work together,” he said.
Benartzi said the Setting Every Community Up for Retirement Enhancement (SECURE) Act’s provision sanctioning an auto escalation cap of 15% makes sense when one thinks about how people started saving late and didn’t save what they should have. He also noted that the increase in job turnover means it is not only important to set a high savings rate, but to get there faster. “Using a design with a 3% default savings rate and auto escalation of 1% per year, it would take more than seven years to get to the cap, and by that time, some employees have changed jobs and are started over at 3% by their new employer,” Benartzi said. “My recommendation is to start with a 7% default savings rate and auto escalate at 2% every year up to 15%.”
The Need for Emergency Savings
Outside of plan design, both employers and employees are realizing that individuals need emergency savings.
Benartzi said he and other researchers are trying to make it easier for employers to make it easier for employees to have emergency savings. “When bad things happen, employees tap into their retirement savings, and we’ve seen some actually cash out their entire account when they don’t need that much,” he said. “Having emergency savings is one way to avoid that behavior.”
Benartzi said he is working on research now about the best way for employers to offer an emergency savings opportunity for employees. He expects results in six to 12 months.
“I’ve been working with an employer that offers an emergency savings opportunity, and one-third of its employees are using it,” he said. “The demand is there. We just have to make it an attractive option for small and mid-size employers to offer.”
Episodes of Voya’s “Hire thru Retire: A Health and Wealth Podcast,” are available through all podcast platforms including Spotify and Apple.
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