The auto DC plan is the talk of the industry (along with TDFs), but we’re still learning how to best manage these relatively new tools to improve participant outcomes while being sensitive to employers’ concerns.
In a newly released white paper, the Defined Contribution Institutional Investment Association (DCIIA), using research from EBRI, outlines best practices on implementing auto plan features to best improve outcomes. While the suggestions might seem simple and obvious, when dealing with plan sponsors who may not have the luxury of spending a lot of time or resources on their retirement plan, simple and obvious are positives.
The Pension Protection Act of 2006 gave plan sponsors safe harbors on a number of fronts, including for state garnishment laws, 404(c) and discrimination testing. Indeed, according to 2012 DCIIA research, 56% of plans used auto-enrollment and 46% employed auto escalation — yielding an increase of 20 percentage points in participation rates with an average opt out less than 10% and a median rate of 5%.
The problem is that the most common deferral rate starts at 3%, capped at 6% for auto-escalation and with a low escalation rate. When participants elect a cap on their own, however, the numbers are far greater:
• 35% select 16%
• 26% select 15%
• 22% select 10%
How does all this affect income replacement ratios, which is really the bottom line? When using a conservative approach on deferral, escalation and caps with new employees not using the deferral rate from their old job, 45.7% of the lowest income employees with 31-40 years of eligibility replace 80% of income (including Social Security) with only 27% of the highest quartile earners. But when using the “robust” model, 79.2% of lower income workers replace 80%, with 64% for the highest income quartile workers.
Impediments to a “robust” auto plan? Plan sponsors are concerned about rising costs and opt out rates, and are confused about the discrimination safe harbors. Armed with this credible third-party research, advisors can show clients and prospects how to improve outcomes with minimal cost and disruption.
