Why the ‘Ideal’ Plan Isn’t

Advisors and providers often talk about the “ideal” plan — but ideal for what?

That’s a rhetorical question of sorts — generally it means “ideal” in terms of providing a better retirement savings outcome. Indeed, I routinely see articles and commentaries (and panel presentations) that self-righteously take employers to task for not “caring” enough about their workers (or their retirement outcomes) to do the “right” things.

While I think our industry views such observations as a challenge, a call to action, all too often I think policymakers and regulators — and certainly the 401(k) “haters” — hear a different message. While I suspect that one-on-one, most advisors allow for a more nuanced perspective on such things, at the risk of stirring up a little controversy, let me offer a different perspective on that “ideal” plan.

Extending Automatic Enrollment to All

Following the passage of the Pension Protection Act of 2006, with its automatic enrollment safe harbor, many likely assumed that plans which adopted the provision would do so for all eligible workers. And yet, nine years on, most industry surveys indicate that the majority (on the order of two-thirds) of automatic enrollment plans have extended that feature only to new hires.

This is a subject that I have broached with plan sponsors and advisors numerous times over the years. Most frequently I am told that there is a great reluctance to “second guess” the participation decisions of workers who have had multiple opportunities over the years to enroll and yet, for a variety of reasons, haven’t done so. And so, whether it’s attributed to “not wanting to insult their intelligence” or a simply willingness to “let sleeping dogs lie,” most plan sponsors I have spoken with simply find it easier (or less painful) to implement new things with “new” people.

One concern that is not generally articulated, but is surely a concern for some, is that automatic enrollment’s very success may be a financial impediment. Doubtless you’ve proudly promoted the surge in participation that embracing automatic enrollment produces. But have you considered what a 20% increase in participation by older, more tenured, and likely higher paid individuals would add to your typical benefits budget?

Automatic Enrollment — at 6%

By just about any measure — and in what has to be the vast majority of situations — starting participants off by deferring 3% of their pay won’t be enough to fund their retirement. It is a start, however, and a better start than many younger and lower-income workers would have in the absence of automatic enrollment (despite the periodic news items and research reports that suggest that automatic enrollment results in diminished savings rates).

There’s a flip side to that level, of course. While a 3% starting rate has the legislative imprimatur of the PPA, long before 2006 it had been widely accepted as a “standard” default rate precisely because it was deemed to be so small that workers wouldn’t take steps to stop their contributions. The experience of the past 30 years supports that premise.

As noted above, 3% is probably not enough — but in looking at the trends in automatic enrollment, 3% remains the “norm.” Moreover, participants tend not to modify that starting default. And since the adoption of automatic escalation noticeably lags the adoption of automatic enrollment, we run the risk of creating a new generation of sub-optimal savers.

Recognizing that disconnect, a growing number of people are calling for a higher starting default rate, generally 6%. Moreover, there many surveys have suggested that inertia is a strong enough force that participants aren’t much more inclined to opt out from a 6% default than they are from a 3% default.

And while a growing number of providers and advisors are touting it — and there are plan sponsors embracing that higher default rate — the vast majority aren’t.

So what’s behind the reluctance to raise the bar to 6%?

Honestly, I don’t think it’s hard to figure out. The reasons cited by plan sponsors vary, and while some still express concerns about employee pushback (see above), it seems fair to think that the typical 20% increase in plan participation rates, coupled with a commensurate increase in match costs, would give any rational plan sponsor pause, particularly to a level that would, in many circumstances, require the maximum employer matching dollars.

Stretch ‘Math’

For sponsors that have pushed back on the match cost associated with automatic enrollment, it’s gotten very trendy to push a “stretch” match. The logic goes like this: An employer that might be reluctant to expand participation (and its employer match) with a match of 50 cents on the dollar up to 6% of pay could instead offer a match of 25 cents on the dollar up to 12% of pay. The match structure is supposed to encourage participants (certainly those motivated by the employer match) to increase their contributions, but the cost of the match to the employer will be the same as under the prior formula.

Well, the math certainly works out. But we’re dealing with people, so let’s just admit that some number of those who contributed 6% to get the match won’t (and in some cases won’t be able to) contribute at the higher level.

But the larger problem — and one that is almost never acknowledged by proponents of the stretch match — is that once you’ve actually had a match program in place, “stretching” out the match is almost certain to be an employee relations disaster for the plan sponsor. The goal may be to keep the cost the same, but workers will almost certainly see the move as a reduction in benefits.

The Cost of Bad Retirement Outcomes

Ultimately the plan design alternatives outlined above don’t require employer involvement to be undertaken by employees, who can enroll on their own, and at levels higher than the standard “auto” defaults provide.

There is, of course, a cost associated with “bad” retirement outcomes: Workers who don’t have (or don’t think they have) enough retirement savings may seek to extend their tenure beyond that considered optimal for the employer. That can impact the employer’s health care costs and impede its ability to hire, retain and promote. And workers worried about their finances and retirement security may well be less productive.

So, yes, Virginia, that “ideal” plan has a price tag. And helping plan sponsors make “better” plan design decisions requires not only an acknowledgement of that fiscal reality, but creative solutions that take those considerations into account.

Add Your Comments

3 Comments

  1. Robb Smith
    Posted August 11, 2015 at 10:50 am | Permalink

    As is usually the case, Nevin, a “right on” post. One of my favorite “ideal” plan perspectives is when academic and industry opponents refer to the “standard” or “typical” 401k plan, such as, “the standard (typical) 401k plan expense ratios are exorbitant”. Just as there is no “ideal” plan there is certainly no “standard” plan. And, way to often the standards used to define standard plans are plans with hundreds of participants and $50+ million dollars of plan assets – hardly your “typical” size plan.

    Another misconception is that all employees are full-time and eligible for benefits. Reality is that current economic stats show historical levels of under-employed and part-time employees (which btw, continue to grow as companies reduce ees hours to stay under ACA qualifying rules). These classes of ees will never be candidates for auto-enroll, auto-increase or auto-qualification no matter the quality of the plan offered.

    And, if we want to see great matches with those companies that matter the most – micro and small employers – they will need to be positively motivated to offer such a plan – i.e. tax credits that costs them little or nothing to offer a plan. IMHO

  2. Steff Chalk
    Posted August 13, 2015 at 10:44 am | Permalink

    Nevin – Interesting charge you levy on the Ideal Plan. As one who has packaged both plan design suggestions and plan sponsor behavioral change – in the interest of delivering plan participants towards better outcomes via larger 401(k) account balances – while simultaneously preparing a workforce for retirement at a normal retirement age… I have used the term the TPSU Ideal Plan.

    From inception during 2013, through the 90th TPSU Program this year, The Plan Sponsor University has used the term Ideal Plan for a portion of the curriculum. The term surfaces when asking Plan Sponsor attendees to design-from-scratch a new Retirement Plan. During the early TPSU Programs, Plan Sponsors were asked to visualize a clean sheet of paper, and then, in the absence of current constraints, Regulation or Legislation, come forth with – “What is your vision of the Ideal Plan? What would you structure to meet the needs of the Plan Participants?”

    After the 90th TPSU Program (held during the spring of this year) the data was an easy read. Plan Sponsors described repeatedly the bold headings of your post. Granted, the early-designers of the TPSU Ideal Plan were a microcosm of the fiduciary-world, consisting of a subset of plan fiduciaries who were seeking education, listening to peers and engaging with industry professionals. These fiduciaries were ones wanting to learn how to improve their own skills and participant outcomes.

    Those who “take the Employers to task for not caring enough” should themselves be taken to task. I cannot speak for the masses who use the phrase; however, The Ideal Plan as presented at TPSU Programs is a learning experience. Most plan fiduciaries are unaware of the massive difference small plan changes can make. Let’s assume the plan sponsor cannot go “all-in” on auto-escalate – but they can make the other changes… Who is harmed?
    If our industry does not show the plan fiduciaries what is possible – we may be stuck with an aging workforce that is too broke to retire and too poor to buy healthcare – so they make-ends-meet by either dramatically cutting back or by working well beyond normal retirement age. Or possibly another government program, designed by bureaucrats and run by politicians for the benefit of American Workers (you and me) will be established to make an attempt at repairing America’s retirement woes.

    My opinion is, presenting the Ideal Plan to plan fiduciaries who are in the position to make a change in their company retirement plan may be one of the biggest “free services” that our industry contributes to every 401(k) Plan Participant. We need to show corporate plan fiduciaries the vision before we can expect them to take-up the charge.

  3. Nevin E. Adams, JD
    Posted August 13, 2015 at 11:02 am | Permalink

    Steff,

    Appreciate, as always, your thoughtful response.

    My point wasn’t that these plan design ideas shouldn’t be broached or promoted, but that I hear far too many touting them without acknowledging the full picture. I guess I’ve sat in one too many conferences where the panel in unison shakes their head at the myopic plan sponsor (who is frequently NOT represented at the conference), as though they can’t possibly imagine why anyone WOULDN’T undertake these changes.

    I appreciate the opportunity that outlining an “ideal” plan can present, certainly in a sales context. But in my experience, plan sponsors (particularly on the finance side) also have to keep a wary eye on the bottom line. “Solutions” that don’t acknowledge those costs/trade-offs (or help plan sponsors rationalize them) likely won’t be viewed as solutions at all – but rather just another problem to solve. And what plan sponsor wants THAT?

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