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Can the 401(k) Avoid a Midlife Crisis?

Can the 401(k) Avoid a Midlife Crisis?

From the Nov 2018 Thought Leadership 401(k) Special Report

401(k) plans represent $5.3 trillion of U.S. workers’ retirement aspirations today. Forty years ago, they were only an idea beginning to hatch, and a rather obscure one at that. Despite the prominent role 401(k) plans play in the lives of Americans, leading experts still believe that participation can (and should) increase. How might that happen? For further insights, read on.


1 Can the 401(k) Avoid a Midlife Crisis?

This month marks the 40th anniversary of the 401(k) plan, originally conceived as a supplemental savings plan to coexist with participation in a defined benefit plan. The 401(k) was never intended to be a sole retirement plan — but that’s the path it has taken. During its lifetime, it has matured in ways that have helped it become more effective, but there is still room for improvement. II spoke with Toni Brown, CFA, senior defined contribution strategist at Capital Group, to discuss the evolution and future of the 401(k).

What do 401(k) plans need to do to avoid having a “midlife crisis” as they turn 40, and to become more efficient tools for plan participants? The 401(k) has to be THE retirement plan in corporate America. There are several things that need to happen for it to be successful moving forward, starting with more participation. Employee participation needs to be north of 95%. Plan sponsors are in a great position to make that happen. They can facilitate auto-enrollment, and repeat that every year as standard practice to sweep people in to the plan and give them every chance to succeed. Along those lines, plan sponsors should auto-enroll participants at a higher percentage of their income. Historically, many plans have done this at 3% of earnings. That simply isn’t high enough. The rule of thumb to have a successful retirement is that workers need to be putting aside 10-15% of their earnings from the day they start working. If you auto-enroll them at 3%, and then auto-escalate at 1% per year, it takes seven years for them to get to 10% — and that’s a long time.

Especially if they switch jobs. That’s right. For example, if they switch jobs at year five and are auto-enrolled at their new company at 3%, they can’t achieve their retirement goals without being proactive. We need plans to have auto-enrollment at 10% and escalate to 15%. Clearly, that is unique to each plan sponsor, demographics, and any company match. Aside from getting people in the plan and investing well, there needs be an in-retirement tier so that participants can stay in the plan after they retire. They can still use the plan, they continue to have fiduciary oversight from the corporation, and they have access to good investments at low fees.

Listen to Lori Lucas CFA, president and CEO of EBRI, and Judy Mares, former plan sponsor and deputy assistant secretary for policy at the Employee Benefits Security Administration of the U.S. Department of Labor, discuss the challenges and solutions for the future 401(k) plans. 

Those are some aspirational goals. Do plan sponsors ever think, “What’s in it for me?” That’s been one of the things that has held back the success of the 401(k) to some extent, and plan sponsors are rightly concerned about taking 10% out of an employee’s paycheck thinking that they’re probably not aware that they’re being auto-enrolled at that amount. It’s natural for sponsors to think employees will be disgruntled and they will have to reverse course. What we’ve seen in practice, however, is that plan sponsors that have auto-enrolled at something like 10-12% haven’t seen any greater pushback from employees than those who auto-enroll at 3% — the opt-out rate does not go up. 

You briefly touched on plans transitioning participants into retirement. What innovations need to occur for that change to happen? Plan sponsors want to start thinking about the 401(k) as a plan that works both when employees are growing assets and when they’re taking assets out in retirement. Often, sponsors have to change their plan documents, they have to work with their recordkeeper to make sure that participants can take money out on a periodic, regular basis without it being overly expensive to do so. They should consider additional investment options which are appropriate for people age 55 and older. Investing when you’re taking assets out — in retirement — is different than when you’re putting assets in. Volatility in the market matters much more when you’re taking assets out, so you have to make sure that you have protection on the downside, and that investment options are created so that they help participants have a smoother ride and ensure their savings last as long as feasible in retirement.

The 401(k) came of age in the time of the baby boomers, but now the workforce is tilted toward millennials. How will their needs drive how the 401(k) evolves? It’s really interesting because for older workers, the 401(k) really was a supplemental savings plan. The assets they accumulated are unlikely to be anything near what today’s millennials will accumulate when you fast forward them to age 65. Millennials are in a really good position as we strengthen the 401(k) system going forward. They think about the 401(k) more as a retirement plan, and that helps everyone. Aligned to that point, many 401(k)s are still called “supplemental savings plans,” or just “savings plans.” That should to change to “retirement saving plans” or “retirement plans.” Simple changes like that will help millennials understand that this is their primary retirement plan, and hopefully, they’ll pay more attention to it.

Millennials are the most comfortable users of technology on the planet. Will technology change how people plan and invest in retirement? I hope we’re able to create technology that is easy to use and is consistent throughout the industry. If we can do that, that will help millennials better understand the process, and better understand the levers that they can influence to have a better retirement. It can help change the perception around plans so that millennials feel “my 401(k) is my 401(k) no matter where I work or what I do, and even after I stop working.” If technology can help them aggregate their 401(k) accounts, it’s a whole new ballgame. Right now, trying to merge separate 401(k) accounts is a manual process that takes a fair amount of work. There’s no reason for that in today’s world; it should be easy to do. It should be something that’s set up electronically so you can check a box when you go from one company to another. Having all the assets aggregated in one place would be beneficial for most participants.

Toni Brown is a senior defined contribution strategist at American Funds, part of Capital Group. She has 28 years of investment industry experience and has been with Capital Group for four years. Prior to joining Capital, Toni was the director of U.S. client consulting and the U.S. defined contribution leader for Mercer Investment Consulting. Before that, she was a senior investment consultant at Callan Associates with management responsibilities for the San Francisco consulting office and the firm’s defined contribution practice. She holds an MBA from Arizona State University and a bachelor’s degree in general business from the University of Denver. She also holds the Chartered Financial Analyst® designation. Toni is based in San Francisco.

Listen to Lori Lucas CFA, president and CEO of EBRI, and Judy Mares, former plan sponsor and deputy assistant secretary for policy at the Employee Benefits Security Administration of the U.S. Department of Labor, discuss the challenges and solutions for the future 401(k) plans. 

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2 401(k) Plans: A Brief History

1978: After being lobbied in previous years by some high earners at Kodak who wished to invest a tax-exempt portion of their salaries in the stock market, the U.S. Congress included Section 401(k) in the Revenue Act of 1978. It became law on New Year’s Day, 1980. 

1980: Benefits consultant and attorney Ted Benna sees potential in the previously overlooked provision, and recommends to a client to take advantage of the tax-advantaged way for employees to generate supplemental retirement savings. The client declined the opportunity, but Benna eventually installed the first 401(k) plan at his own employer. 

1981: The IRS allows employees to contribute to 401(k) plans via salary deductions. 

1983: Of U.S. companies with 500 or more employees, nearly half offered 401(k) plans, or were thinkng seriously about doing so. 

1990: 401(k) plans in the U.S. are actively participated in by 19 million people. 

1996: Assets in 401(k) plans top $1 trillion for the first time. 

2001: New legislation allows for increases in contribution amounts by individuals and companies, and provides those 50 and older an opportunity to make catch-up contributions. 

2006: The Pension Protection Act provides statutory authority for employees to automatically enroll employees in DC plans. 

2008: 401(k) assets reach $2.2 trillion in the U.S. – or 16% of the U.S retirement market. 

2018: As of June, U.S. 401(k) plans held an estimated $5.3 trillion in assets – 19% of U.S. retirement assets. 

Listen to Lori Lucas CFA, president and CEO of EBRI, and Judy Mares, former plan sponsor and deputy assistant secretary for policy at the Employee Benefits Security Administration of the U.S. Department of Labor, discuss the challenges and solutions for the future 401(k) plans.

3 The KISS Method of 401(k) Plan Design and Review

By Carl Gagnon, AVP, Global Retirement Programs, Unum Group

When defining a retirement program that is centered on a DC component, some plan sponsors and participants desire, and often can, choose from countless shapes and flavors of plan designs and investment options. This might strike some as a reflection of the diverse composition and needs of the U.S. workforce, but I would argue there is a balance between offering the right amount of choice and adding plan features and investment options that create excessive complexity and confusion. Excessive plan features and investment choices can muddy participants’ understanding, impede engagement, and create choice paralysis – any and all of which can lead to poor decisions, or (even worse!) inactivity.  

U.S. employees are generally quite willing to save for retirement and gain financial wellbeing, and they want choices in their benefit offerings. But they need a program that makes sense and is easy for them to work through to a decision, and importantly, participants want guidance, education, and communication to help them make informed choices. 

So, how do plan sponsors achieve a balance of offering a strong, yet simple DC product that meets the objective of helping participants achieve better retirement and financial wellbeing?   My mantra for 401(k) plan design and review is KISS, or Keep it Simple, Sponsors. Here are a few keys to doing just that:

Make sure your company and your fiduciaries are on the same page

Insuring that the objectives of the 401(k)/DC plan are clear is an important first step. If you’re trying primarily trying to help employees effectively save for retirement and meet their financial needs, why add complexity that goes beyond that? Sure, there are scenarios where a plan sponsor and its fiduciaries offer a retirement savings program with complex plan components that could be favorable for its membership. For the majority of employer sponsors, however, those are unlikely scenarios. The Department of Labor clearly identifies a few of the responsibilities of plan fiduciaries as the following: 

  • Acting solely in the interest of plan participants and their beneficiaries with the exclusive purpose of providing benefits to them; 
  • Paying only reasonable expense of administering the plan and investing its assets;
  • Making sure that participants have sufficient information on the specifics of their investment options, so they can make informed decisions.  
  • Make sure your fiduciary committee includes individuals that are engaged and knowledgeable about your 401(k) plan and its purpose. Regular training is important, as are regularly scheduled and attended meetings with agendas that include consistent periodic discussions of industry, regulatory, and plan design options. Include your investment managers, consultants, and your plan’s recordkeeper in these meetings will help to insure you are being thorough in your approach and diligence.  

Keep designs simple 

One of my actuarial consultants once said to me, “If you’ve seen one retirement plan, you’ve seen ONE retirement plan.” Every company or plan sponsor has their own idea as to what should be included in a 401(k)-plan design. Remind yourself that it’s your employees’ plan – you may be the sponsor, but they must live with your design. You can simplify your plan and increase participation by…

  • Offering auto-enrollment and auto-escalation.
  • Keeping to a smaller investment lineup that’s clearly categorized for employees.
  • Grouping investment offerings in tiers (active, passive, target date) and avoiding other “fringe” investment structures.
  • Using target date funds as the investment default investment option (QDIA).
  • Developing and regularly reviewing a clear and concise investment policy statement.
  • Providing tools that are easy to find and that help employees predict 401(k) balances at various ages and, just as importantly, that help them maximize their company matching contributions. 
  • Including predictive modeling that helps create understanding of the assets members will need to last their lifetime. 
  • Giving access to an investment advice and guidance service, either through your TPA or another source. 
  • Offering one loan, followed by standard hardship withdrawal provisions. 
  • Allowing a simplified distribution and withdrawal option.

Creating a plan that offers these features will help employees feel comfortable with the plan design. 

Periodically (and not less than annually) review the plan at an asset and individual fund and investment option level.

Regulators look for plan sponsors to complete a periodic review of the adequacy of their investment lineups. The diligence of your review, including the need for a reasonable lineup and an appropriate number of investment choices, is key. This type of review goes beyond the typical exercise that looks at performance versus benchmarks, and helps you and the fiduciaries determine if your lineup has the appropriate number and type of investments. Ask these questions: 

  • How many investment options is enough?
  • Is there investment overlap or too much correlation within the lineup?   
  • Can you achieve an appropriate level of diversification while eliminating some of the investment options?  
  • Can you add diversification to participant portfolios without increasing the number of fund choices by broadening the existing offerings?

Review what your employees (and your company) pay for fees

This might be the most challenging work you will complete, and you’ll need to be actively involved with your third-party administrator and your investment consultant. Ask the following questions: 

  • Are there cheaper available investment share classes? Can collective investment trusts or separate accounts be utilized in place of higher cost mutual funds? 
  • Is the administration cost of the plan a flat fee or bundled into the cost of investments? Is there an opportunity to simplify this and become more fee transparent to your membership? 
  • Are there additional processing fees (loans, hardships, statement fees, etc.) that have simply been in place for years and serve no purpose? Are these fees competitive with your peers?  
Reviewing the answers to these questions should become a normal part of your fiduciary diligence. Even if fees appeared reasonable in your last review it doesn’t guarantee that circumstances haven’t changed, or that the investment market hasn’t shifted since that last review.  

Carefully consider the value of plan elements to participants. 
Brokerage links are a good example. They do add exposure to the full market, but continue to show low utilization among plans that offer this investment “tier.” They are also difficult to understand for many (even most) employees, offer specific stock risk not present in mutual funds or collective trusts, and continue to lack clear direction from the Department of Labor on best designs or safe harbor practices. 

ESG is a newer trend than brokerage links, but it should be considered carefully. Participants like the spirit behind ESG, but ESG funds are generally more expensive than other funds, and don’t necessarily provide the same risk and return characteristics. The April 23, 2018, Department of Labor Field Assistance Bulletin specifically reminded fiduciaries that economic performance should be the primary driver of investment decisions before any potential social factor or benefit is considered.   

It is necessary as a plan sponsor and fiduciary to be aware of new DC trends and to discuss them at least annually so you can be prepared to address any that become mainstream plan offerings, and that make sense to offer in a timeframe that fits you and your employees.  

Designing and operating a plan requires ongoing fiduciary diligence. Keeping it simple for your members can add value above what you’ll achieve by attempting to position the plan as a solution that has everything for all investors. A lack of employee knowledge and data overload can only add to poor choice and retirement results. Keeping the points above in mind should result in:

  • Better membership participation.
  • More engaged employees (both in the plan, and in their job because they are less distracted by financial wellness issues).
  • Better savings behaviors and retirement outcomes (leading to better workforce management results).
  • Better investment choices.
  • Lower investment fees.
  • Less operational and fiduciary risk as a sponsor. 
Carl Gagnon, AVP, Global Retirement Programs at Unum Group, is responsible for the day-to-day operations, regulatory oversight and compliance of the Unum global retirement programs which include their Defined Benefit, Defined Contribution and Non-Qualified retirement plans and various flex benefit programs within its international operations. Unum employs approximately 11,000 employees worldwide with key U.S. locations in Chattanooga, Tenn., Columbia, S.C., Portland, Me., and Worcester, Mass. Globally, Unum has operations in England, Ireland, and Poland. Gagnon is also involved in developing, implementing, and aligning these global retirement program designs with the overall business objectives of Unum, and serves as a key partner in the implementation of the strategy, design, and investment structure for these financial benefit programs. He has 25 years of experience in various HR and benefit positions, including benefit strategy, managing corporate benefit programs, and implementing administrative systems to manage plans. Prior to joining Unum in 2005, Carl worked in similar roles with Apogent Technologies, Thermo Fisher Scientific, and in the Taft Hartley benefit field. He holds a CEBS certification, is a Fellow in the American College of Healthcare Administrators, and is a member of Society for Human Resources Management and the International Foundation of Employee Benefit Plans.

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