If the goal of a 401(k) Plan is to prepare employees for a secure and prosperous retirement, then too many plans fall short. But some simple changes in plan design will dramatically improve the odds that your employees will have a good outcome. The best news is that they don’t cost the employer anything.
The 401(k) was never designed to provide a standalone comprehensive retirement plan like your grandfather had. Among its many faults is that it transfers almost the entire responsibility for planning, funding, managing and monitoring to the employee. Most employees are not actuaries, investment managers, or financial planners. Even rocket scientists or heart surgeons generally do not have the training or inclination to take on those responsibilities.
We all know that Americans are not saving enough for retirement, and that few are maximizing their plan benefits. The statistics are devastating. Whatever we can do to assist our employees to achieve financial security and live in dignity during retirement will pay big dividends.
Our brains are not wired for success in long term planning. We don’t value future benefits as highly as current satisfaction. Given a choice between a new cell phone today and a secure retirement 30 years from now, the cell phone generally wins out. And, it’s trite but true that most people spend more time researching a big screen TV than planning their retirement. Even if they wanted to, few have the time, training or inclination to design optimum funding levels or an optimum asset allocation tailored to their needs.
It’s no secret that far too many employees fail to engage with their retirement plan. Those participants cannot be expected to have a good outcome.
Faced with choices they may not understand, with no context for decision making, and no urgency to respond, they do what I might do in other complex problems I don’t fully understand. My default mode in situations like that is procrastination and inertia. It goes on the back shelf where it most probably dies a cruel lingering death. This is not helpful behavior for plan participants. It’s not likely to end well.
The Pension Protection Act (PPA) President Bush signed into law in 2006 incorporated behavioral finance research to enable substantial improvements in 401(k) plans. But 13 years later far too few plans have adopted them. The PPA Safe Harbor changes gently “nudge” employees in the right direction.
Prior to PPA, the default for almost all 401(k) plans was not to enroll, not to contribute, and if you did enroll and contribute the default investment was some type of cash or guaranteed account. Those plans couldn’t have been designed better to guarantee failure. And most plans were dismal failures. PPA turns those provisions around.
Now properly designed default options incorporating the PPA Safe Harbors can have a dramatically better outcome for employees. Even if the employee makes no choices and does nothing but show up for work, better plan defaults will guide him to a decent retirement accumulation.
With these applied provisions, the employee can be automatically enrolled, the plan can call for an initial contribution amount, that amount can escalate over time as the employee’s compensation raises, and the Qualified Default Investment Alternative (QDIA) option can be set to a target date fund, target risk asset allocation, or separately managed account chosen to meet the needs of the employee group demographics.
It’s critical to understand that default options do not limit employee choice. The employee can opt out or modify any provision at any time. But vast experience with both our clients’ plans and across the entire retirement industry indicate that the overwhelming majority won’t.
You might expect employee pushback. But, it hasn’t happened. Overwhelmingly employees accept the defaults as employer recommendations. In almost all plans adopting these default provisions participation, average deferrals and average account sizes increase exponentially along with employee satisfaction with the plan.
Even if the employee never engages with the plan, the minute that employee is hired the plan is on autopilot and headed in the right direction. Over time the employee gets to an adequate level of funding with an investment plan suitable to the task.
Your employees deserve a plan that will work for them. If your company’s 401(k) plan hasn’t been updated in the last few years, perhaps now would be a good time to dust it off to see if it’s doing all it could to get them to a prosperous retirement. The PPA provisions will greatly enhance the value of your plan to your employees for no additional company cost. Where I come from that’s a Win-Win solution.
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