4 Fiduciary Resolutions for 2024

A brand new year awaits us – and with the New Year comes an opportunity to assess and reassess – for some when, resolutions for the cessation of bad behaviors and the beginning of better ones are in vogue. Here are some for plan fiduciaries for 2024 – that could benefit plan outcomes for years to come. 

See if your target-date options are over-weight(ed) 

 

Flows to target-date funds have continued to be strong – and little wonder, what with their positioning as the qualified default investment alternative (QDIA) of choice for most 401(k)s. That said, the vast majority of those assets are still under the purview of an incredibly small number of firms – nearly all of which (despite marketing brochures to the contrary) appear to share very similar views as to what an appropriate glidepath is supposed to look like – and nearly all of which have embraced the notion that a target-date is little more than a speed bump along the “through” target-date glidepath. 

 

A target-date fund is, of course, a plan investment. Like any plan investment, if it fails to pass muster, a plan fiduciary would certainly want to remedy that situation, including removing the fund if necessary (don’t take my word for it – that’s coming straight from the Labor Department). Particularly in view of recent market volatility, it’s worth (re)examining the asset allocations – and perhaps most significantly those that are applied to target dates that are near-term – and ask yourself – should an individual within five years of retirement have that much invested in those options?     

 

Look, the reasons cited behind TDF selection run a predictable gamut: price/fees, performance (past, of course, despite those disclaimers), platform (as in, it happens either to be their recordkeepers or compatible with their program) – and doubtless some are actually doing so based on an objective evaluation of the TDF’s suitability for their plan and employee demographics.  

 

Whatever your rationale, it’s likely that things have changed – with the TDF’s designs, the markets, your plan, your workforce, or all of the above – and it’s probably (past) time you took a fresh look. 

 

Pump up the default rate in your auto-enrollment plan

 

While a growing number of employers are auto-enrolling workers in their 401(k) plan, one is inclined to assume that, a decade and change after the passage of the Pension Protection Act, if a plan hasn’t done so by now, they likely have some very specific reasons. 

 

But for those who have already embraced automatic enrollment, those are plans that have (apparently) overcome the range of objections: concerns about paternalism, administrative issues, cost – some may even have heard that fixing problems with automatic enrollment can be – well, problematic (though things have gotten a little easier on that front). 

 

With more than a couple of decades of experience under our belts (a third of that under the auspices of the Pension Protection Act of 2006), we know a couple of things. First, 3% isn’t “enough” (ironically, that is probably what accounts for its popularity – it’s small enough that it wasn’t thought to spur massive opt-outs by automatically enrolled participants). We also know (or should) that the auto-enrollment safe harbor of the PPA calls for a minimum starting deferral of 3%, which is a floor, not a ceiling. And finally, that – at least according to any number of industry surveys – a default contribution rate twice as high as the prevalent 3% would likely not trigger a big surge in opt-out rates. However, there is a great deal of difference in the retirement outcomes between the two. 

 

On an encouraging note, more than half of the respondents to the 66th Annual Survey of Profit-Sharing and 401(k) Plans now have an initial default contribution rate in excess of 3% - and nearly as many (27.6%) have a rate of 6% as do (29.2%). 

 

Give reenrolling a second thought 

 

There is a natural human tendency to apply change from a point in time forward, to apply a new approach in plan enrollment, like automatic enrollment only prospectively, to workers who join the company after the point in time at which it is effective, rather than retroactively. And sure, workers who have had their chance to enroll voluntarily may well, in their refusal to do so, have spoken their intent not to participate at a previous point in time. 

 

However, that was then and this is now. If they don’t want to participate, it’s easy enough to opt-out. But maybe they didn’t fill out that form the last time because they forgot to, because the investment menu was too complicated or intimidating, or maybe the valid reason(s) they had then no longer applied. 

 

Regardless, don’t you owe them the same opportunity that you are giving your new hires? 

 

Develop a plan budget

 

Most financially-focused New Year’s Resolutions focus on spending (less) or saving (more)—and the really thoughtful ones do both—all tied around the development of a budget that aligns what we have to spend with what we actually spend.  

 

Most (many?) plans have a budget when it comes to the expenditures that require corporate funding. Less clear is how many establish some kind of budget when it comes to what participants have to spend. Now, granted, what they pay will vary based on any number of …variables—but an essential part of ensuring that the fees paid by the plan (for the services provided to the plan) is knowing how much—and for what.  

 

At some level, that means not only keeping an eye on things like expense ratios, the options with revenue-sharing and the availability of alternative share classes (or options like CITs)—but it also means having an awareness not only of the plan features but the usage rates of those plan features. 

 

Because when it comes to retirement plans, there often IS a direct link between spending less and saving more.

- Nevin E. Adams, JD

Match vs. Defaults

Which is more powerful—a generous match, or a high savings rate default? 

As it turns out, Christmas Eve brought us a new white paper with the fairly innocuous title, “The Impact of Employer Defaults and Match Rates on Retirement Saving.” Indeed, there have been plenty of surveys (and tons of data) that speak to this issue (many of which are cited as references in the paper)—but underneath that bland title the authors take on an intriguing question, specifically how, and how differently, the deployment of specific plan design features—the employer match, or default enrollment—impact retirement savings.

With regard to the former, there’s been plenty of real data to buttress the notion that the employer match acts as a virtual target for retirement savings—with employee contributions clustering around those like moths to a flame, regardless of the savings needs or income wherewithal of the participant. Similarly, we’ve long—but even more so since the advent of the Pension Protection Act of 2006– seen the dynamic impact that default savings rates—making individuals “opt out” rather than sign up—for retirement savings routinely produce participation rates north of 90%. 

Now, these plan designs have long been seen by employers (and those who support them) as positive forces to encourage workers to avail themselves of these critical benefits. On the other hand (and somewhat cynically), both can be seen as devices to produce retirement deferral rates sufficiently high to permit retirement plans to pass the muster of the various nondiscrimination tests to which they are subjected. And let’s face it, both carry costs for the employer(s) sponsoring the program. Indeed, if there is a shortcoming to these mechanisms at all it is that employees have seemed to assume they represent an answer to the “how much should I save” question, rather than simply being a function of how much the employer chooses to spend on benefits.

‘Better’ Idea?

As it turns out, the researchers (David Blanchett of PGIM DC Solutions, Michael Finke of the American College of Financial Services & Empower’s Zhikun Liu) have an answer to the question as to which is “better”—well “better” meaning the plan design that results in the highest employee savings rates, highest acceptance of the default investment, and lowest disparities in savings rates by income—that would be the one that uses a high default rate and a lower employee match.

 More specifically, based on a review of the activities of approximately 157,000 participants[i] who recently enrolled in an employer-matched 401(k) plan, they conclude that “a higher default rate has the largest impact on employee savings rates.”

Not only that, they caution that “plans with low default rates (say 3% or 4%) that match a high percentage of employee earnings induce higher-income participants to actively move away from the low default savings rate, resulting in a wider savings gap between higher- and lower-income employees.” On the other hand, setting a high default means that “fewer move away from the default savings rate resulting in higher and more equal savings rates among employees.” 

Other Considerations

There are some other considerations. They note that low default rates and high match rates also result in significantly fewer employees remaining in the default investment, and that while “raising the default savings level should increase savings rates for new participants, it won’t necessarily help existing participants.” As a consequence, the researchers comment that “plan sponsors may also consider different kinds of reenrollment or plan-reset options to utilize the positive impact of default savings rate increase. Additionally, plan sponsors should also consider including provisions for automatic savings rate increases to further boost participant savings levels”—because the one thing we know about most retirement savers is that—like Newton’s 1st Law of Motion—an object at rest remains at rest. And that’s what happens to most participants defaulted at a specific saving rate and in a specific investment—they stay there.

They also note that a high match appears to motivate workers to make an active decision to save more only when placed in a low initial default rate. Moreover, they found that a higher match motivates higher-income workers to save more, but only motivates lower-income workers who are defaulted (at the aforementioned 3% or 4% savings rate). They found that, when defaulted at a higher savings rate, the match rate only motivates high earners to increase their savings rate.

All in all, the match seems to matter to those who are more actively involved with the decision to join the plan—and those who are defaulted into the plan, in general, don’t seem to be those. There’s also a sense that more highly compensated individuals are more aware of, and active in, maximizing the match—though that may create nondiscrimination testing issues since less highly compensated workers seem to be more inclined to simply stay with the default rate.

Ultimately, of course, what matters is the default rate and the terms of the match; and with any luck at all, it’s not either or, but both!

- Nevin E. Adams, JD

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[i] Not that it matters, but the paper specifically cites “the second largest recordkeeper for retirement plans in the United States, which services over 12.8 million DC plan participants across approximately 67,000 retirement plans as of the third quarter of 2021”—Empower.

4 Retirement Savings Benchmarks That (Generally) Miss the Mark

Behavioral finance tells us that human beings are prone to relying on heuristics – mental shortcuts, if you will – to solve complex problems. While these may not be very accurate, survey data and anecdotal evidence suggest that participants often rely on these benchmarks.

Here are four that workers use more often than we’d perhaps like to admit.

The Company Match

Survey data and academic research have long suggested a link between the employer match and the level to which workers contribute. Indeed, there has been evidence (frequently invoked by advocates of the so-called “stretch” match) that it’s not the amount of the match that motivates, but the existence of the match at any level.

There is, in fact, evidence that a lot of people save only as much as they need to receive the full employer match (unfortunately, there’s also evidence that many don’t take full advantage – particularly lower income workers – and confusion about how much you need to save to get the full match.

There are, of course, a number of factors that go into determining the amount and level of the match; how much individuals need to set aside for their own personal retirement goals is almost certainly not one of those factors.

Saving to the level of the employer match is certainly a good starting point, but unless it’s truly extraordinary – well, it’s likely not “enough.”

The Automatic Enrollment Default

While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today – as it was prior to its codification in the Pension Protection Act more than a decade ago – remains 3%. There is some interesting history on how that 3% rate originally came to be (it’s been the standard default for such programs going back to when they were still called “negative elections”), but the reality is that it has become that default because it is widely seen as a rate that is small enough that participants won’t be willing to expend the time and energy to opt out (if they even notice the withholding).

Little wonder that in automatic enrollment plans at Vanguard, more than half (55%) are contributing below the match initially, and one in five (21%) is still below that level after three years.

For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%. And though there are indications that the default savings rate is moving up from the traditional 3%, there is one thing that you’d like to think everyone knows.

Saving at a 3% rate, unless you have alternate financial resources, is definitely not “enough.”

The Pre-tax Cap

At the height of the Rothification “scare” (and make no mistake, we’re not out of those woods yet), there was a sense that existing automatic enrollment programs might be affected. Specifically, that plan sponsors wouldn’t be comfortable simply continuing to auto-enroll above whatever pre-tax cap was established by legislation ($2,400 was the rumored level at that moment) without some independent approval by the participant (setting aside the irony in turning to an automatically enrolled participant for some direction). Moreover, some providers had echoed that sentiment, saying that they would feel obliged to place that cap in the plans they recordkeep with automatic enrollment provisions — at least until plan sponsors told them otherwise. And if plan sponsors aren’t comfortable making that switch with their automatic enrollment programs — well, you can see how that Roth limit could in short order actually become a limit on retirement savings.

But one of the more unique arguments I heard against Rothification at the time was that that a pre-tax cap, whatever it turned out to be, would be viewed by workers as some kind of de facto sign from the government that the amount they would allow you to save on a pre-tax basis would be seen as a proxy for the “right” amount to save for an adequate retirement.

And just about the time you find yourself thinking, “there’s just no way anybody could be that stupid” – the sad reality sinks in.

A Guess

In the 2017 edition of the Retirement Confidence Survey, just 4 in 10 workers (41%) report they and/or their spouse have ever tried to calculate how much money they will need to have saved so that they can live comfortably in retirement (the all-time high was 53% in 2000). Not surprisingly, workers reporting that they or their spouse participate in a retirement plan are significantly more likely than those who do not participate in such a plan to have tried a calculation (49% vs. 15%).

Now, over the quarter-century (and change) of its publication by the nonpartisan Employee Benefit Research Institute, the Retirement Confidence Survey has produced any number of interesting, compelling, and even startling findings. And yet, the one that continues to puzzle me is not the percentage of workers who say that they have ever tried to calculate how much they need to save for a comfortable retirement – but the proportion of those who say that evaluation was based on… a guess. That’s not a finding included in this year’s RCS, but in the past, it was as much as 45%.

Several years back, those individuals were asked how much they need to save each year from now until they retire so they can live comfortably in retirement; one in five put that figure at between 20% and 29%, and nearly one-quarter (23%) cited a target of 30% or more. Those targets are larger than one might expect, and larger than the savings reported by RCS respondents would indicate.

All of which brings to mind the following; were the savings projections so high because so many workers didn’t do a savings needs calculation — or did participants avoid doing a savings needs calculation because they thought the results would be too high?

Or both.

Benchmarks can provide a ready and relevant measure of progress against goals. But if the goal is short of the need, the benchmark may be of little use.

There’s an old saying: “If you don’t know where you’re going, you’ll probably end up somewhere else.” And indeed, for many retirement savers who are relying on unreliable benchmarks, that “somewhere else” could be a pretty unpleasant destination.

- Nevin E. Adams, JD