The 401(k) Toolkit

Got five minutes? The topic of this blog post is covered in our Fiduciary Five Podcast series hosted by Chuck Hammond of the 401(k) Study Group. The Fiduciary Five Podcast…your fiduciary questions, answered in about five minutes.  To listen to the related podcast, click here.

I’d like to think of myself as a pretty handy fellow. There is something really rewarding about seeing a problem, coming up with a solution and grabbing my good ole’ toolkit to get it working properly.  Now whether you are a regular ‘Tim the Toolman Taylor’ or you’ve got a handyman or handywoman on speed dial, the reality is that without the proper tools, most likely the job isn’t going to get done.

In our industry, we’ve got a big problem to fix. The 401(k) was instituted to help people retire, but it’s not working.  Our most recent study shows that on average only 33% of retirement plan participants are on track to achieve an adequate benefit at retirement.  The problem is that most retirement plans put too much responsibility on the employee. Few individuals know how to set a goal, join the plan, save more money as time goes on, invest sensibly, and monitor his or her outlook. Let’s face it, most participants are not financial experts, yet currently their success depends solely on their ability to make expert-like decisions.

So, if 401(k) plans are going to be the primary retirement vehicle, we need to identify the best tools to fix the problem and by doing so help participants achieve a meaningful retirement.

Auto enroll can be packaged in different ways to best suit individual plan needs, but the bottom line is that it takes the pressure off of the participant and helps set them up for success. For instance, many would consider inertia to be a detrimental behavior but with auto enroll it becomes a beneficial behavior as most participants will follow the path of least resistance and stay in the plan.

Often sponsors become paralyzed while adding auto enroll in fear that they will be perceived as making a choice for the participant; however, participants will always have the option to opt out and most don’t, because of inertia and they know they need help. They are looking for someone to provide them with the answer.

The next tool sponsors should consider is to select a higher default savings percentage. Research shows that the opt out rate from auto enrollment is no different if the default savings percentage is 2% or 6%.  When considering the best interest of the participant, the rate should be in direct correlation to the percentage that captures the most match for the participant. For instance, if the match formula is 100% up to 3% and 50% on the next 2%, auto enroll should be set at 5% to prepare the participant for retirement by taking full advantage of the matching dollars.

Now that the foundation is set, let’s help participants build their savings through the use of auto escalation. Auto escalation adds a percentage annually to the participant savings rate.  The escalation percentage is disclosed in the annual participant notifications and an opt out provision is allowed.  You have the option to put a cap on the escalation, which I’m personally a proponent of, but the cap should be set at a point where the savings rate is meaningful for a successful retirement. Participants should really be saving 15% to 20% of their income.  By adding 1-2% annually, with a cap at 15% over the life of the plan, the participant is now positioned for success.

Auto enroll and auto escalation are powerful tools. Consider putting them in your toolkit!

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