We spend a lot of time discussing “retirement readiness” and how important a goal it is for our employees.
Let’s realize that working towards retirement readiness for our employees can be a win-win—an obvious win for our employees as they save more and become more optimistic that they’ll be able to enjoy a robust retirement, and a win for the company, both in helping our employees reach this goal and in minimizing the long- term costs of having employees who can’t retire.
How do we help our employees achieve retirement readiness? “Automatics” have given us the answer. For years, plan sponsors have struggled trying to get higher participation in their plans, as well as higher deferrals. Then along came automatic enrollment, and voila! The results have been astonishing. One speaker put it this way: “automatic enrollment succeeded where billions of dollars in communications efforts failed.”
So what have we learned? In a nutshell, four things.
- When we change from the traditional “opt-in” system (people need to make an election to join the plan) to an “opt-out” system (people have to make an election to not participate), you get significantly higher participation across the board.
- Very few people elect anything but the default deferral set in the plan.
- Data has shown that very few people make changes to their elections. Basically, unless there are automated changes, many (likely most) people keep their elections and don’t make changes.
- When auto-escalation is added to the plan design, the percentages of people who opt out are similar to those for auto-enrollment without the deferral increase. In essence, very few.
So why, with the increase in auto-enrollment plans, are we still talking about problems achieving retirement readiness? Some automatic programs may actually be hurting, rather than helping.
It is basic human nature that people adopt a default. Behavioral finance has studied this extensively. If you have a 3% default deferral—which is very common—most of your employees are likely to just pick this level.
Even worse, because of another human characteristic—inertia—they will probably stay at that level for their entire career, unless you also have auto-escalation built into your program. Employees often assume that the default level in a plan has been chosen because this will be the level they need to save for retirement. This is an unfortunate assumption; the company is generally setting defaults at a level they feel they can afford, not necessarily the level that will achieve retirement readiness for employees.
So what happens if you have a default 3% employee deferral built into your plan? Let’s assume the most common plan design, a 50% match on up to a 6% employee deferral. Many employees will just go for the default and stick with 3%.
Two big problems. First, they are leaving money on the table—their employer matches up to a 6% deferral, but they are only getting a contribution based on 3%. Second, they are saving way too little for retirement. Unfortunately, they are probably thinking they are doing the right thing by participating at the level the employer has set and are not even aware that they may be facing a large deficit in the savings they need when it comes time for retirement.
In this instance, they are deferring 3%, getting a 1.5% employer match, and ending up well below the levels experts have calculated as the amount that should be saved—these estimates range anywhere from 12-20% of compensation, well above the default level of most auto-programs.
What can be done? In the example above, I would suggest three things. First, change the default deferral to 6%. Data has shown that there will be very few participants who don’t stick with this default, likely about the same percentage who wouldn’t stick with the 3% default.
Second, I would change the match formula. Consider the impact of matching 25% up to 12% employee contribution. The company still has a 3% maximum contribution, but now the employee would be saving at a15% level!
How do we get the employees to the 12% level? That’s where auto-escalation comes in—my third suggestion. If we increase the deferral by 2% each year—a level that data again supports as having minimal opt-outs—in three years the person would be up to that full 12% level. And now they would be on the path to achieving retirement readiness!
We’ve now passed the first generation of auto-programs, and overwhelmingly they have gotten significantly more people to participate in retirement savings programs. Now we’re ready for generation two. With some simple tweaks, we can really see our participants start socking away some significant savings and getting well on the road to retirement readiness.
This is just one simple example of how large a role proper plan design can have in helping our employees achieve retirement readiness. During our Mid-Sized Retirement and Healthcare Plan Management Conferences, we go much more in-depth about different strategies that have proven successful.
Our upcoming Las Vegas program at Caesar’s Palace, September 7-10, is the last Mid-Sized Retirement & Healthcare Plan Management Conference in 2014. Please reserve your spot now while spots are still available.
Hope to see you in Vegas.