The 7 Highly Effective Habits of Highly Effective 401(k) Plans
Every so often someone puts out a list of what are said to be the “best” 401(k) plans, based on varied benefits and plan design structure criteria. But for my money, here’s what the best plans do.Make it easy to start — right.
No matter how well done the materials, the time allotted to education about the options, or the simplicity of the enrollment form(s), signing up for benefits is, for most, a time-consuming, tedious, and somewhat stressful process. There are, of course, individualized factors to be considered, but when it comes to enrolling in your workplace retirement plan, I can’t imagine why any employer would want to subject their workers to anything other than the ability to opt out, or to increase the starting default rate of an automatic enrollment.
Oh, and start that default contribution rate at 6% of pay, not 3%. Surveys indicate that participants aren’t much more likely to opt out at that rate, and you’ll be giving them a better chance to not only maximize the match, but to have a financially secure retirement.Make it easy to invest.
Things got a lot easier for automatic enrollment programs when the Pension Protection Act of 2006 introduced the concept of the qualified default investment alternative (QDIA), particularly with the embodiment of a target-date fund — although balanced funds, managed accounts, and custom TDFs could all fit the bill as well.
Of course, not all TDFs are created equal, and the process of selecting and monitoring those options is not without its fiduciary brambles. Still, the advantages — not only in terms of the simplicity of choice for the participant, but more importantly the ongoing oversight and rebalancing of these portfolios — make them an invaluable way for individual retirement savers to start and stay on the proper course.Make it easy to increase contributions.
Regardless of the initial deferral rate, at some point – say, after the kids are out of college, or the car is paid off — most individuals should consider a higher rate of savings. One of the dangers of making it so easy/automatic to get started is that people may not know how to change those settings. Look for opportunities to not only remind them of that opportunity, but to direct them to the place/form/link where they can do so.Make it just a bit hard to get money out before retirement.
Whether they should or not, it seems that most Americans do all, or at least most, of their saving in their workplace retirement plan. And that means that when a financial emergency occurs, many participants are inclined to tap into their 401(k), either as an in-service or a hardship withdrawal, or as a participant loan. In the case of withdrawals, there can be significant tax and penalties that could significantly diminish the amount available for the emergency, while loans – long touted as “borrowing money and repaying interest to yourself,” generally have an impact that, while temporary and sometimes modest, nonetheless have a negative impact on retirement savings.
From time to time, there are those who push to close off pre-retirement access to these funds, addressing what is generally positioned as a “leakage” problem. But common sense dictates that if you tell people they can’t get to this money until they hit retirement age, they are likely to put less money aside in these plans.
That doesn’t mean that a well-run plan has to make it so easy to get at that money that participants do it without thinking. Reminders about the financial constraints, taxes and penalties accompanying the withdrawal should be a given, as are pointers on alternative sources to consider. Additionally, there are clearly administrative costs and burdens associated with fulfilling these requests, and it’s reasonable to ask that those who are making them to cover those costs.Foster awareness of costs as a part of investing.
Another casualty of the “auto” plan regime is that it’s easy for individuals to lose sight of the reality that there is a cost to their 401(k) — and some may even come to believe that their 401(k) is “free.” A well-run plan will generally have costs that are not only reasonable, but are at a level that a plan fiduciary can (and should) be proud of. Look for opportunities to share and explain those plan costs. Participants will better appreciate their program — and you’ll be helping them learn the right questions to ask when (or if) they do leave the plan.Encourage participants to establish savings goals, and track progress.
Participants, writ large, tend to assume that things like the employer match level are a signal for the “right” amount to save. That’s likely even more true in auto plans, where the rate of savings and the investment choice are all chosen for the worker. But, as noted above, individual circumstances are different, financial needs in retirement are not only varied, but constantly changing.
That’s why, no matter how well designed or effectively utilized the plan is, participants need to have access to, and be encouraged to use, a retirement needs calculator or assessment, if not an individual consultation with a trained advisor. Yogi Berra once famously said, “If you don’t know where you’re going, you might not get there.” That goes double for retirement planning
.Make it easy to get money out at retirement “right” — via a systemic withdrawal option or annuity purchase.
We all talk about how much harder it is to draw down, or decumulate, one’s savings than to accumulate — to not only figure out how much you need to save for retirement, but to determine how much, and how best to withdraw those sums once you are in retirement. And yet, today industry surveys show that only about half of the defined contribution plans in existence have any kind of systemic withdrawal provision in place such that, if participants were inclined to try and set up scheduled withdrawals, they could. More sophisticated lifetime income options are even harder to find, particularly as an in-plan option.
The concerns most plan sponsors (still) have they have for a reason, of course. That said, the options are getting better, the ability of retirement plan advisors to help plan sponsors find and make those choices continues to improve, and the Labor Department just last year published some additional guidance
that may help fiduciaries feel more comfortable about making those options available.
There is, of course, one final “habit” that the best 401(k) plans have in common: They hire an experienced and knowledgeable retirement plan advisor to help them not only make, but implement, the practices above until they do become habits.