Ever wonder why saving for retirement is so difficult, and why your company’s 401(k) participation rate is not as high as you’d hope? Behavioral economists have. And they believe that choosing to save is the sort of choice that is inherently difficult. That’s because the benefits and costs associated with this choice are separated in time.
Like exercise. Even when you make it to the gym there may be no evidence of all your hard work for weeks. And when it comes to retirement, a young adult choosing to sock away money today to spend decades later is making a very difficult decision.
But 401(k) plan sponsors are up against more than just tough choices. Sometimes 401(k) plans are not all that easy to join. Even incentives like a hefty employer match can fail to drive significant participation. Add to these hurdles one more: human error. We forget about the email alerting us to join the plan. We lose the enrollment paperwork, or forget our password to the website.
For an illustration of sheer human oversight, consider the 25 U.K. pension plans that required absolutely zero contribution from employees. They were fully funded by the employer, and all employees had to do was sign up. Yet only about half of the employees enrolled in this offer for free money. They just dropped the ball.
This is what plan sponsors are up against. Yet 401(k) plans often require a high participation rate to ensure they do not benefit highly paid employees at the expense of everyone else – a violation of ERISA rules.
Luckily for employers and employees alike, plan sponsors can use human nature to their advantage when designing 401(k) plans. With the right plan design, a 401(k) can attain high participation rates, and high salary deferrals that increase each and every year.
1. Automatically enroll everyone into the plan.
Typically, employees have the option either to enroll or not to enroll in the company 401(k). That is, the default option is to have employees opt-in to the plan. That means action is required to join. Not so with automatic enrollment. With an auto enroll feature, the default option is to join the plan, and opting-out requires action.
Given what we know about human nature, we would expect higher participation rates for plans with auto enrollment. But 82%? That’s the average participation rate in plans where Vanguard’s small plan division provides recordkeeping services. The participation rate for these smaller plans with voluntary enrollment is just 57%. That’s a huge difference.
A high 401(k) participation rate as the result of auto enrollment means two things: Most people join the plan, and virtually everyone stays in the plan.
Traditionally, younger and lower paid employees are the least likely to participate in a 401(k). Yet the vast majority of these two groups tend to remain in the company 401(k) when they are enrolled automatically. Companies that automatically enroll employees see over 90% of employees stay in the plan. As a result, the participation rates for these hard-to-reach employees are far higher when they are auto enrolled. A breakdown by age group of participation rates where Vanguard’s smaller plan group serves as recordkeeper is presented below:
Similarly, auto enrolled employees at the low end of the salary range are far more likely to remain enrolled and saving for retirement than employees who must opt-in to participate:
2. Get employees to save real money with a meaningful deferral rate
There’s nothing like automatic enrollment to boost your 401(k) participation rate. But automatic enrollment alone does not make for a sound plan design. In fact, while auto enroll may encourage more employees to join the plan, a low initial deferral rate can have participants saving less than they would otherwise.
Consider the Vanguard plans mentioned above. These 401(k) participants saved 6.9% of their salary on average in 2016. But there was quite a savings gap between those who were auto enrolled and those who signed up voluntarily. The average auto enroll deferral was 5.7% compared to 7.3% for employees who signed up on their own.
As the table below shows, most of the Vanguard plan sponsors with automatic enrollment chose to set the default rate at just 3% of salary:
We know that employees aren’t great about joining plans requiring them to opt-in. The same goes with deferral rates. Once they are in the plan, employees may not think about their 401(k) salary deferrals for years. Behavioral economists recognize this as a tendency to stick with the status quo. That’s one reason why at ForUsAll, we suggest a deferral rate of at least 6% – read other tips on increasing employee 401(k) contribution rates here.
3. Turn everyone into a saving machine by automatically increasing deferral rates
Ok, so employees can be slow to change the portion of their salary directed to the 401(k). Maybe they think that the low 3% rate was chosen because it is all that is needed to prepare for retirement. After all, that was the rate selected by the plan sponsor. The rate picked by the plan sponsor can act as an “anchor” – this is an behavioral economics concept where participants instinctively rely on the number selected by the plan sponsor as a good savings amount. Or maybe the 401(k) participants just never get around to changing the deferral rate on the plan website. That email reminding them about plan adjustments may be buried in an inbox, or worse, new plan information is stuck inside an unopened envelope.
Whatever the reason, good plan design can encourage employees to save more retirement dollars. At ForUsAll we recommend that an auto escalation feature be combined with the higher initial deferral rate. That means salary deferrals automatically increase each and every year, helping to place your employees solidly on the path to retirement success. That way, when employees make no changes, they are doing something big for their retirement nest egg.
4. Make it easy to take action or make changes
Employees should be able to boost their savings rate or change investment allocations at the push of a button. These options should be no more than one or two clicks away. Checking a 401(k) balance should be especially easy. And making things easy is important for employees to have the best shot at building a solid nest egg. Without a way to quickly and easily take action, many employees will fail to implement their best intentions and likely stick with a low savings rate.
If your 401(k) provider requires some hoop jumping to make simple changes, consider these work-arounds:
5. Explain the 401(k) in terms everyone can understand
The dirty secret about financial services communication is not that financial advisors, banks, and insurance companies hire terrible product marketers that are part robot, part dictionary. Nope, they’re confusing on purpose. Not knowing how much you’re paying, a confusing fund line up, getting only a fuzzy picture of how much work you’re expected to take on yourself — any one of these will drive down 401(k) participation, and make you less effective in managing the plan.
Odds are that your employees aren’t experts in financial planning or investment management. They may not even be familiar with many of the terms tossed around in the world of 401(k)s. And when faced with choices to make in unfamiliar territory, it is only human nature to postpone these important decisions. Perhaps indefinitely.
The key to engaging employees with the 401(k) is clear and understandable communication. Here’s an example of a communication tool we’ve developed that seems especially effective. Just click the play button:
You may have noticed that our narrator, DAVE, puts the employee in the driver’s seat. He provides just enough information, and ample opportunity for the employee to replay a particular section. By asking questions, DAVE can present the information most relevant to that particular employee.
This chat with DAVE is based on our research that 401(k) communication should meet employees where they are. Whether an employee is fine with the default option, or wants to switch investments, DAVE explains how the 401(k) works for them.
If your current 401(k) materials are dense and confusing you could ask your provider to come up with better communication options, or you could use some of our 401(k) resources and try to translate the financial gobbledygook yourself. Of course that may or may not happen. You might be better off trying to schedule time with your current advisor and arranging for one-on-one help.
Certainly there are more than five ways to improve 401(k) participation and savings, but these five actions can get your plan over some of the biggest hurdles. While a lot of the retirement plan experience is determined by your provider, there’s still a lot you can do to empower employees to join and make the most out of the company benefit.
If you are thinking about checking out other providers, ForUsAll can help. You can use our 401(k) Shopping Checklist to help you evaluate individual providers. You can see an overview of the 401(k) Shopping Checklist on our blog, and download the complete document from the same page.
ForUsAll handles all aspects of plan administration for the employer, reducing oversights and errors that trip up many small businesses managing their own 401(k). As our Chief Investment Officer David Ramirez says, ForUsAll is “a super easy 401(k) that works — for both employees and employers.”
Give your employees more than just a 401(k), join the movement.