A recent survey run by Callan in the fall of 2016 provided a source of large plan 401(k) change intelligence and 401kTV wrote a nice article about this survey identifying several of the large plan trends they recognized as valuable for smaller plans. One key finding highlighted was the increase in auto enrollment and auto escalation. The survey noted large plans have dramatically increased their use of auto enrollment, a behavioral nudge, to help increase retirement savings; so what do small plans need to know before they act to make plan design changes that include these auto enrollment features?
Before adding an auto enrollment feature start with understanding your plan’s health base line. This base line’s foundation is the percentage of current deferral rates for all participants. It is not enough to just look at participation rates, rather it is important to identify the income replacement gap of the participants in the 401(k) plan. Although it might be obvious that if the plan’s participation rate is 46% many of the participants are not saving enough to reach a comfortable retirement, it may not be as obvious if the participation rate is 75%. Looking at the details of this higher participation rate however may show that the participants’ deferrals are so low that again many will not reach their retirement goals. They will need a nudge and how much of a nudge will be determined by the gap analysis seen at a plan level.
Why is it important to know the actual plan level savings goal to be fill, the plan’s retirement income gap? The simple answer is we know goals are rarely met that are not identified and quantified or as the saying goes “what is not measured is not achieved”. We also know we have a fiduciary duty to run a 401(k) plan in the best interest of the participants and to meet this duty we need to identify what steps will provide better outcomes for these participants which can only be seen from a detailed view of the current plan’s health. Plus knowing the 401(k) plan’s retirement ratio will be very important to setting the initial auto enrollment level. Do not assume that the often quoted 3% auto enrollment is best for your plan; in fact a 5% auto enrollment default is often preferable to participants even though many 401(k) plan executives feel that would cause employee push-back. It has been shown that participants that were auto enrolled at 5% felt less likely to “opt-out” since it appears to be a more meaningful savings in their 401(k) and particularly if they received a match to that 5%. It is interesting to note it was not important if the match was dollar for dollar or 25% on the dollar rather it was the knowledge that they were receiving the match on the entire 5% deferred, a better incentivized nudge.
The plan level gap analysis is a good foundation to the base line but it does have a shortcoming, as it does not account for the time a participant has to fill their gap. The gap might be the same for a participant with 4 years till retirement as one with 40 years yet it is obvious that time is critical to filling that gap. A more accurate view can be seen by calculating the actual risk of dependency on unrealistic investment returns to reach each participant’s retirement goal if they do not change their current savings habits. Bdellium calls this the MR3 number. MR3™ is the annualized Minimum Required Rate of Return that a participant would need to fully fund their expected retirement income needs, given their expected benefit entitlements and current savings behavior. A higher MR3™ indicates greater dependence on investment returns to fund retirement and therefore a higher risk of not achieving a comfortable retirement. Once a solid starting point or goal has been determined then look at the cost of implementing auto-enrollment and auto-escalation strategies to reach that goal.
The cost of an auto-enrollment must be combined with an optimization of the company contribution. There is no need to increase a plan’s budget rather look to redesigning and optimize how a company spends their current contribution. What may surprise many 401(k) plan fiduciaries is that often times an optimized design with auto enrollment and auto escalation features lowers the first few years’ cost. Spend your budget wisely implementing small design changes that are targeted to improve participant outcomes. Document how these auto-enrollment and auto-escalation features will improve outcomes for your plan participants and you will have documented your fiduciary duty. Continue to monitor the success of your plan design changes and adjust as needed.
Ask your advisor to run a plan design optimization report and you will have all the necessary information to make an informed decision. Auto enrollment and auto escalation features can be ideal for smaller 401(k) plans and can help meet your fiduciary duty to provide a plan that is designed to be in the best interest of the participants.
