Helping Employees Help Themselves to Retire
by Ilene H. Ferenczy
PLAN OPTIMIZATION/PLAN DESIGN
401(k) plans are more than just a necessary part of a compensation package designed to attract new employees. They are (or should be) programs that help employees prepare for retirement.
Must an employer help its people prepare for retirement? Isn’t that the employee’s responsibility? It may be, but leaving employees to save as they see fit may harm the company, too. As a company’s employee population ages, it is hard to transition these employees to a reasonable exit if they have no financial security. Without proper retirement assets, an employee will hold onto his or her job … sometimes for way too long, impeding the ability of the company to bring in new blood. A lack of retirement savings is short-sighted for both the employee and the employer.
So, how can the company help employees save for their retirement?
Change the 401(k) Default
Normal 401(k) plans assume that, if an employee does not elect to save money from payroll, he or she does not want to contribute. Often, however, an employee’s failure to elect is more due to inertia than actual decision-making, since it is easier for an employee to do nothing than to complete an election form. Also, having to decide on investment options can be time-consuming and intimidating, which is another reason the form often is not completed.
A plan can use inertia to its advantage by simply changing the meaning of an employee’s failure to act. Automatic enrollment – also known as negative election – changes the default so that an employee who does not fill out an enrollment form is deemed to have elected to save a stated amount (commonly 2-6% of pay) to the plan. Under this structure, an employee who takes no action will nonetheless contribute to the plan.
Does it Work?
Studies show that plans with automatic enrollment experience a higher rate of employee savings than those that do not. They also indicate that, once savings begin and the 401(k) account grows, employees get the “bug” and begin to adopt the savings culture. (Not incidentally, this likely helps the plan pass its nondiscrimination testing.)
It Can Even Get Better
Often, the automatic enrollment rate is too low to provide sufficient savings for retirement for all but the youngest of employees. Therefore, employers that really want to help employees prepare for their later years take one more step: automatic increase. Under this structure, the default rate for the employee contributions increases each year, usually by an additional 1%. So, for example, the employee will default to contribute 3% via automatic enrollment in his or her first year of employment, 4% in the second year, 5% in the third year, and so on. The increase rate is commonly capped. The trend, however, is to cap at a higher rate, as most employees need to save 10% or more to have a meaningful retirement.
Just as with automatic enrollment, inertia helps automatic increases stay in effect. This is especially true when the timing of the automatic increase aligns itself with the annual cost of living or merit increases. Of course, the employee can always opt out of the automatic increase by completing a form.
Aren’t These Automatic Savings Structures a Payroll Hassle?
Most payroll systems have been improved to accommodate automatic enrollment and increases. If the payroll provider is brought into the loop when the provision is added, the process can be less painful than it was in earlier times.
If you are going to have a 401(k) plan, why not help your employees use it to their best advantage, and allow the company to prepare for the future at the same time? It makes good sense (and cents)!
Ilene H. Ferenczy, Esq., CPC, APA is the managing partner and thought leader for Ferenczy Benefits Law Center, an Atlanta firm focusing on the practical issues affecting retirement plans, the companies that sponsor them, and the people who service them. She is the author of five books and more than 100 articles about retirement plans and is a former third-party administrator.