In the United States today, more than 630,000 employer-sponsored defined contribution plans are in place to help nearly 90 million Americans prepare for retirement. How successful will these plans be?
Most employers evaluate success based on plan metrics, such as participation rates, savings levels and the performance of the investment options relative to selected benchmarks. However, these metrics don’t accurately capture whether or not an employee has built sufficient savings to support their income needs in retirement.
Few Americans are saving enough for retirement. Traditional pillars for retirement have weakened—underfunded pension plans are being phased out, Social Security payments will likely shrink for future retirees, and with longer life expectancies, we can all count on needing more money during retirement.
Today, personal retirement savings plans, often through an employer-sponsored plan like a 401(k), are the heart of our retirement system. But this system requires that individuals make their own investment choices and determine how much to save. The reality is today’s workers aren’t saving enough and aren’t investing appropriately.
As employers, we used to assume if we have a retirement plan, like a 401(k), employees will enroll, and we have done our part. But have we really?
There is a more stringent test for retirement plan effectiveness that we should all consider: How prepared for retirement are our employees? Although you have provided every planning tool, the best investment lineup and a generous match, if employees don’t participate and don’t follow through on what they really need to do, you really haven’t helped them.
Many of us have extensive education programs in place and verbally stress the importance of saving for retirement. This alone is not an effective approach, as retirement participation plan rates have remained flat for nearly 20 years (averaging about 60 percent of employed individuals). There are two important changes employers can make to their defined contribution plans to immediately improve participants’ engagement and commitment: automatic enrollment and automatic savings increases.
Maximizing automation in your plan design is a simple and well-received way to keep your employees engaged. In that very first introductory meeting, in which new employees learn about their options and actually pay attention to their contribution amounts, encourage them to sign up for automatic investment increases or build into your plan a requirement that employees would actively have to opt out of this option.
A Vanguard calculation illustrates how an average 25-year-old with an annual salary of $25,000, who receives modest annual raises and an employer match of 50 percent of the first 6 percent and automates increases of 1 percent a year until reaching 10 percent, would end up with a balance of $1.2 million at retirement. Starting at the same age and investing only 6 percent annually with no auto increase nets out with only $600,655.
Westminster Consulting clients report that their employees don’t even notice the extra money coming out of their paychecks, and they admit that if it weren’t for the automated increase, they wouldn’t have increased their savings. We know that people tend to miscalculate how much they need to save for retirement; the auto increase ensures they stick to their own savings plans.
Another new trend is automatic or forced enrollment. Employees are defaulted into the plan in an age-appropriate investment, and though some employees choose to opt-out, we find a majority of people stay in the plan.
According to a recent Fidelity study, over the last two years, 39 percent of employers included auto enrollment in their plan design and 29 percent included an annual increase program. Our clients who have embraced these options all confirmed an increase in participation and savings rates.
As employers, we should want what’s best for our employees upon retirement. They’ve worked hard and helped our companies grow. At the very least, we should help them grow their own nest eggs so they can live comfortably in their retirement years.
Sean Patton is a founding partner of Westminster Consulting, where he currently works with corporate, non-profit and foundation clients.
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