To make meaningful change in the retirement industry, advisors and sponsors can work together to put the needs of the participant first and help them achieve retirement success. (Photo: Shutterstock)

"When a flower doesn't bloom, you fix the environment in which it grows, not the flower. __ Alexander Den Heijer

Much like flowers need the proper environment to bloom, 401(k) plan participants need the right plan to thrive and achieve a successful retirement. Retirement plans need to be modernized to consistently provide the structure for success, and enhancing the tax deferred contribution benefits of the 401(k) is key. This is rooted in four areas:

1. Plan design strategies: Utilizing automatic enrollment and progressive savings escalators
2. A focus on retirement readiness and outcomes: Shifting the plan sponsor oversight focus from fees and funds to meaningful results – participant retirement readiness
3. Thinking outside of the retirement box: Embracing other QDIA alternatives, such as managed account solutions
4. Facilitating a better process: Making it EASY for both the participant and plan sponsor

Understanding the past before charting a forward path

Before implementing any of these solutions, an understanding of the past is required.  Looking at the evolution of the 401(k) plan will inform us on how to improve it for the future.

For the participant, their retirement plan programs have followed the natural progression of evolution.  They have morphed from simple employer funded programs, such as a defined benefit plan or an employer funded profit-sharing plan, into a much more complex program, the very recognizable 401(k) plan that dominates today.

This evolution has been gradual, but very impactful on the retirement landscape today.  The original proponents of the 401(k) never considered that it would become the predominant retirement program in America.  In fact, the 401(k) was originally thought to be a supplemental retirement program to the traditional defined benefit plan and Social Security.

Changes from 1978 to today have taken us from predominantly employer-funded retirement programs to predominantly employee-funded programs, shifting the financial burden primarily to employees.  This shift has posed many challenges for employees to adequately prepare for and fund their retirement.

Comparing the defined benefit plan structure to the 401(k) plan structure points to several key differences, but the biggest difference boils down to one thing: who is making the decisions.

In defined benefit plans, all major decisions are made by the plan fiduciaries and their cadre of prudent experts.  Conversely, in most 401(k) plans, the majority of these decisions fall to the comparatively inexpert participant with help from the service provider's array of investment products, on-line calculators and tools.

Modernizing to a DB-like structure

"Even if you're on the right track, you'll get run over if you just sit there." __Will Rogers 

To modernize to a framework that feels more like a defined-benefit structure, the 401(k) plan should incorporate automatic enrollment and progressive savings escalators.  If the plan has already implemented auto features, review and recommend new features to improve utilization and effectiveness.

Automatic features have gained popularity since the enactment of the Pension Protection Act (PPA) in 2006.  And while this design feature has proven to improve plan participation, average deferral rates and overall plan results, the adoption rate has been relatively slow.

The benefits of automatic enrollment are beginning to take shape.  According to Vanguard's 2019 Edition of "How America Saves," automatic enrollment has tripled since year-end 2007, with 48% of plans adopting automatic enrollment.  Two thirds of the automatic enrollment plans implemented auto increase, with the most common default being a 1% increase annually.  Ninety-nine percent of all plans with automatic enrollment default participants into a balanced investment strategy, with 98% of plan sponsors choosing a target date fund as the default. Among new hires, participation rates nearly double to 93% under automatic enrollment, compared with 47% under voluntary enrollment. Over time, eight in 10 participants increase their contribution rates, either automatically or on their own, while three-quarters of participants remain exclusively invested in the default investment fund.

The default decisions made by plan sponsors have a powerful influence on participant saving and investment behaviors, such as the minimum default participant contribution rate.  The good news is that plan design improvements are reflected in the numbers, with over 50% of plans choosing a 4% or higher default rate, compared to only 27% of plans in 2007.

Interestingly, 23% of plans choose a default of 6% or higher, compared to only 6% of plans in 2007!  One common concern for plan sponsors is whether the plan will experience a high level of opt outs if the default rate is set too high.  Another Vanguard study suggests that is not the case.  The participation rate among employees in this study was around 85%, regardless of whether the initial contribution rate is 2% or 6% or somewhere in between.

It has been over 12 years since automatic enrollment and progressive-savings escalators arrived on the retirement scene.  As demonstrated in the numbers above, we have seen a positive impact on participant savings behavior, but there is room for more improvement.  Re-energize the auto feature design by doing the following:

1.    Offering participants the ability to fund Roth in addition to the pre-tax account

2.    Conducting a "sweep" on all non-participants into the plan every few years

3.    Re-evaluating your initial contribution level, increase to 6% if possible

4.    Re-evaluating your auto-increase escalation percentage, take the approach of Moses – go 2 x 2

5.    Considering other investment alternatives to the traditional QDIA, target date funds

Oh, and if your plan administrator or committee pushes back on these design recommendations because it might be too hard for them administratively, try to identify the "why" of this objection.  It may just be that it stems from how they handle payroll and other benefits and that can lead to a whole other consulting opportunity.

Allow retirement readiness to drive all decisions

"Insanity is doing the same thing over and over and expecting different results." __ Albert Einstein

What should be the #1 goal for a retirement plan? Providing a successful retirement for your participants!  And yet, research on retirement readiness in the U.S. suggests that only roughly 25% of participants in defined contribution plans are on track for a successful retirement.

If you look at any benchmarking survey over the past 15 years, plan sponsors' number one goal is to improve participant communication and education.  To measure success, the two primary indicators of an effective 401(k) plan are participation rate and average deferral rate.  However, over this same time period, those indicators have basically gone unchanged at approximately 79% and 7% respectively.

To make meaningful change in this industry, we need to put the needs of the participant first and help them achieve retirement success.  As advisors, this is an opportunity to shift the focus from fees, funds and fiduciary to tangible and measurable results that you create.  Now that is rewarding work!

Monika Hubbard is an Institutional Retirement Consultant with Unified Trust Company responsible for overseeing distribution of Retirement Plan services in the Southeastern United States. You can reach Monika at (859) 514-6195 x227.