How to focus on participation and savings in your company’s 401(k)
So you want your retirement plan to be successful… That means you want your employees to join the company 401(k), and you want them to divert a meaningful portion of their paychecks toward the plan. And all along the way you’d like to make sure your plan passes IRS discrimination tests by not becoming “top heavy.”
All of these goals are reachable with the right plan design and clever use of technology.
For example, a great way to help achieve widespread, high employee participation in your retirement plan is to enroll employees automatically. This “auto enrollment” immediately gets employees on the road to tax deferred savings. This feature has become increasingly popular, helping to boost participation rates in 401(k) plans in recent years.
But some employers have reservations about auto enrolling their employees into the company plan. They may, for example, be wary of making such an important financial decision on behalf of their workers. Let’s look a bit more closely at that concern.
To save or not to save in the 401(k)…
To paraphrase a well-known playwright, that is not exactly the question.
It seems that most employees understand the purpose of the 401(k), and once they learn a bit about the plan, they want to participate. But many don’t. Why? We did our own study to find out.
We had “Dave,” our virtual advisor, ask the employees at a 500-person company who had yet to join the 401(k) why they hadn’t. A full 40% said they were too busy and another 19% said that enrolling was too much of a hassle.
That’s a whopping 59% who basically said that the difficulty of joining the plan overwhelmed their understanding of the plan’s benefits. “Difficulty” in this case could mean a couple of things. If the onboarding process is chock full of paperwork, the time and energy required to sort through the clutter may be reason enough for workers to procrastinate – perhaps indefinitely. In addition, in order to enroll, employees must make their own investment decisions. Delving into the various mutual fund options, not to mention determining their own asset allocation, is lot to think about. Lots of paperwork combined with confusion about investing can result in “choice overload.” It’s like that feeling you get when standing in the cereal aisle, but worse because your retirement is at stake.
(Related content: 5 Tips to Boost 401(k) Participation)
And consider this, most employees probably do want to be in the plan. A clever researcher from Harvard did a study to find out how much of a difference these retirement seminars make. They interviewed participants following onsite educational seminars and found that nearly 100% of them “intended” to join the retirement plan after attending. However, over the next 6 months, only 14% actually did so.
The bottom line is, because your employees can always opt out after auto enrollment, they are still responsible for making the decision whether or not to save. Auto enroll simply presents the decision in a way that behavioral scientists would applaud – it allows them to avoid choice overload. Deciding to enroll in a retirement plan with several investment options ceases to be a “multidimensional problem” and becomes a simple binary decision – “Do you want to stay in the plan or not?”
Keep behavioral science on your side when setting initial deferrals
Another knock against auto enrollment is that workers won’t take the time to adjust the initial savings rate. In fact, the retirement researchers at Aon Hewitt found that the average savings rate in retirement plans with auto-enrollment is actually lower than in plans where employees must opt into the 401(k). That’s because auto-enrollment plans often start with a very low rate, like 3%. Employees often simply don’t get around to hiking that low default savings rate. Yet, the amount socked away into a tax deferred account becomes more important each and every year that passes.
Here’s where a good plan design can help. Your 401(k) plan can encourage responsible savings by deferring a meaningful amount at the outset, and then automatically bumping up that amount year after year.
At ForUsAll, we not only recommend a default savings rate of 6%, but we also explain, via our virtual advisor, “DAVE,” that 6% is only starting point for salary deferral. To make the most of their 401(k) plan, employees should then work toward maxing out their contributions well before retirement.
The automatic deferral savings rate you choose will be an anchor point – a cognitive bias that is hard to overcome. Like it or not, people tend to rely on the first data point when making a decision. By picking a low initial contribution level, you are likely to send the message that that is the right amount to choose, or that the low amount is a valid reference point
Automatic enrollment can be much more than a box to be checked when setting up your 401(k). It can be a cornerstone to a highly engaging benefit. When combined with a reasonable initial deferral rate, automatic increases, and frequent communication with employees, your 401(k) can enjoy widespread participation and solid employee savings.
As of September 2016, ForUsAll clients were realizing participation rates of 89% with savings rates of 7.4%. We think this is a big deal! It shows that ForUsAll is accomplishing its mission by addressing America’s retirement problem. But successful retirement plans also matter to our clients because they are offering a benefit that is being used. And getting more employees to join the 401(k) plan and save at high rates helps companies keep their plans compliant and pass the annual IRS nondiscrimination tests.
As a sponsor of a 401(k) plan, that should automatically put a smile on your face.