The defined contribution structure carries its own risks, however. A host of competing financial priorities, including high student and other debt burdens, child-rearing and providing home care for elderly family members, paired with a lack of financial literacy, have kept the saving rate stubbornly low; the opportunities and incentives that 401(k)s provide are only a partial counterbalance. For the plan sponsor, these low savings rates bring the risk that many employees will not be able to relinquish their jobs by the time they reach retirement age. Our recent survey of over 500 sponsors of 401(k) plans with assets of $50 million and above, in partnership with Prudential, found that although 61 percent say the overall health of their 401(k) plan is excellent, large groups judge their plan only fair to poor when it comes to:
- Company match (42 percent),
- Range of asset classes and categories offered (45 percent),
- Quality of investments offered (42 percent),
- Competitiveness of fee structure (44 percent),
- Expense ratio (47 percent) and
- Financial education programs (45 percent).
Why do so many plan sponsors fall short of creating well-designed 401(k) plans? In a series of one-on-one interviews with plan sponsors and consultants, we identified five key areas of vulnerability that expose employers and employees to greater retirement plan risk.
Not funding the plan: A substantial employer match is critical to a successful 401(k) plan, consultants say — not just as an incentive to employees to participate and maximize their contribution, but also because it encourages them to value the benefits the company offers and therefore the company itself. Employer match levels vary widely, however, and have not been consistent over time. Many plan sponsors reduced their match during the financial downturn of 2008–’09 and have only slowly restored it, if at all, notes Jennifer Flodin, defined contribution practice leader at Pavilion Advisory Group Inc..
Leakage: Money that goes into 401(k) plans does not always stay there. Leakage of assets can occur in three ways: through loans, in-service withdrawals and cash-outs when employees change jobs. The Employee Benefit Research Institute has estimated that for workers with at least 30 years of 401(k) eligibility, leakage reduces the probability of achieving an 80 percent real replacement rate, including 401(k) accumulations and Social Security benefits, by 8.8 percentage points for the lowest-income quartile and 7 percentage points for the highest.
“People change jobs five or six times in their careers, and they don’t move their money” into an IRA or into their new employer’s plan, says Robyn Credico, defined contribution consulting leader at Towers Watson. “This is a big topic, but nobody goes out and prevents them from spending their money when they leave.” The plan structure may inadvertently be enabling participants to reduce their retirement assets even when they remain at the same job for years. “We have to find ways to limit the ability for participants to derail themselves through multiple loans and in-service withdrawals,” says Flodin. “People aren’t talking about this as much as they should.” At USG Corp., a building materials manufacturer whose $1 billion-in-assets 401(k) plan enjoys high participation and contribution rates, Tom Foley, director of employee benefits, says that if he could change one thing, “it would be to take another pass at restricting loans and withdrawals.”
Solving the wrong problems: Consultants agree that many plan sponsors spend too much time deliberating over their choices of investment options and too little considering whether the overall plan structure is appropriate for their employee demographic. “Participants are unique; therefore, plan sponsors need to consider all sources of net income when they’re designing a plan,” says Mark Teborek, senior consulting analyst at Russell Investments. Determining the plan design structure inclusive of auto features and whether or not to offer a Roth 401(k) option are examples of decisions that need to be made thoughtfully, taking participant demographics into account, says Flodin. Similarly, education all too is not tailored to participants’ level of financial literacy. “Consider an approach that talks about overall financial wellness instead of stale large-vs.-small-cap discussions,” she suggests.
Lack of resources: Creating and maintaining a well-designed 401(k) plan takes money and time — which many smaller plans do not have. “Everybody is short-staffed right now,” Credico says, “and they don’t necessarily have the time to make appropriate decisions.” Almost two thirds (62 percent) of plan sponsors we surveyed, along with 81 percent of respondents in an accompanying survey of consultants and advisors, agree that providing one-on-one advice on asset allocation and financial planning is very effective. “Ninety-five percent of my clients would love to have a financial wellness solution that includes one-on-one advice,” says Flodin. “But it’s costly.” Another very effective practice is to focus on keeping plan fees and other costs low, say 61 percent of survey respondents and 69 percent of consultants. But obtaining better fees is easier for large plans. “At our size, we get good fees,” says Robert Hunkeler, vice president of investments at International Paper, which has $5 billion in 401(k) assets.
Reluctance to act: With the rapid growth of 401(k) assets has come greater scrutiny from government. While the Pension Protection Act of 2006 provided a safe harbor for important features such as automatic enrollment and target date funds, the Department of Labor (DoL) is intensifying its involvement. The DoL recently drew attention with its new fiduciary standard for 401(k) investment advisers; last year it issued a request for information on the use of brokerage windows and self-directed brokerage accounts.
Plan sponsors are paying close attention to these developments: 33 percent say a changing regulatory environment will have a very high impact on their plans in the next three years. Some consultants express concern that small plans in particular may be less likely to add features that nudge participants to save more and save better, if they think it may attract scrutiny. “Nobody does anything without clear guidance from the DoL or the IRS,” says Paul Denu, defined contribution practice leader at USI Consulting Group, whose 401(k) clients average about $40 million in assets. “Once they say you can, only then do most plan sponsors adopt these more contemporary features.”
Despite these risks automatic enrollment and auto-escalation, as well as greater data-crunching capability enabling recordkeepers to track participant behavior more closely, could make it easier for even small plans to work with participants and encourage them in the right direction. But nothing beats a substantial company match, Denu adds.
Auto Enrollment: An automatic contribution arrangement that can be used as a feature in a retirement plan to allow employers to enroll employees in the company’s plan automatically upon meeting eligibility requirements.
Auto Escalation: A plan design option that allows a plan sponsor to increase participant deferrals annually by a set increment.
RISKS: Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.
The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the target date funds will become more conservative as the target date approaches by lessening the equity exposure and increasing the exposure in fixed income type investments. The principal value of an investment in a target date fund is not guaranteed at any time, including the target date. There is no guarantee that the fund will provide adequate retirement income. A target date fund should not be selected based solely on age or retirement date. Participants should carefully consider the investment objectives, risks, charges, and expenses of any fund before investing. Funds are not guaranteed investments, and the stated asset allocation may be subject to change. It is possible to lose money by investing in securities, including losses near and following retirement.
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