Thirty years ago, half of all workers in the United States had a traditional pension plan, according to the U.S. Department of Labor. That meant that in retirement, they received a decent-sized check in the mail each month. By 2010, the percentage of employees covered by a pension plan had slipped to 7%. Today, the lion’s share of companies (69%) sponsor 401(k) retirement plans. But not all employees participate, and some who do participate fail to tuck away enough of their salaries to ensure an adequate retirement.
Although 74.4 million workers have amassed $3.1 trillion in savings in their 401(k) plans, according to a 2012 Deloitte study, that’s a drop in the bucket. In a separate Deloitte survey of a broad base of employers earlier this year, 15% said less than half their employees participated in the 401(k) plan. With regard to participants’ savings rate, employees in the half of the plans that required automatic enrollment were saving a paltry 3%, according to the Defined Contribution Institutional Investment Association.
The non-profit association, which is dedicated to enhancing the retirement security of American workers, says that’s not nearly enough in savings to ensure a reasonable standard of living in one’s golden years. Others agree.
“By the time you retire, you generally need to have 10.6 times your final year of earned income in savings,” says Barrie Christman, vice president of individual investor services at Principal Financial Group, a Des Moines, Iowa-based investment manager and retirement adviser. “To get to this amount, you would need to be saving at least 11% of your income each year, including the employer match. A 3% default savings rate, even with a 50% match by the employer, is a whopping 4.5%—a far cry from what is needed.”
Many employers take these issues seriously. According to a survey of plan sponsors by The Principal, 43% say they offer a retirement plan because they view it as their obligation to assist employees in saving for their retirement.
“Employers have the societal burden of ensuring that people start saving early in their 401(k) plans, and save as much as they can, to improve the health of the retirement system in the United States,” says Kristi Mitchem, global head of defined contribution at State Street Global Advisors, a Boston-based asset manager.
Two concepts resonate loudest in this regard—automatic enrollment of plan participants and automatic escalation of participants’ default savings rate. Auto enrollment, which requires employees to opt out of a 401(k) plan in writing, has been particularly effective in increasing plan participation. “Our numbers indicate that when employees have to enroll in the 401(k) plan, only 70%, on average, do so,” says Joel Shapiro, senior vice president of ERISA compliance at 401(k) Advisors, an Aliso Viejo, Calif., retirement planning consulting firm. “Employers that require employees to opt out of the plan, on the other hand, enjoy a 90% plan participation rate.”
Shapiro chalks up the difference to human inertia. “When 401(k) plans came on the scene a generation ago, many people were confused and found the [investment] choices daunting,” he says. “So they threw up their hands and did nothing. By automatically enrolling them in the plan, you overcome their apathy.”
While retirement advisers agree that auto enrollment has made a huge difference in the overall savings of employees, they criticize the savings rate of 3% of salary traditionally used as the default when automatically enrolling employees. “It’s definitely too low a peg,” says Josh Cohen, defined contribution practice leader in the Chicago office of asset manager Russell Investments.
Brigitte Madrian, Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School in Cambridge, Mass., agrees the rate will get retirees nowhere near what they will need to live on. “Sixty percent of plans have a default contribution rate of 2% or 3%, which is on the conservative side,” she says. “Historically, the reason for this is that employers were afraid if they picked a higher default rate, more employees would opt out of the plan. This is not the case empirically, however. We find that at 6% and higher, opt-out rates barely budge.”
Madrian, Cohen and others say employers could easily double the traditional default rate in the first year of plan participation. “Since automatic enrollment has proven its merit, why not enroll people at the maximum level for receiving an employer match?” says Alan Vorchheimer, a principal at Buck Consultants. “If the plan matches at 6% of pay, why not enroll people at 6%?”
There is another way to increase the savings rate—by automatically escalating it each year by one percentage point until it reaches a threshold of, say, 10%. To maintain their current savings rate, employees must opt out in writing. At present, only half of 401(k) plans that automatically enroll participants subsequently automatically escalate their savings rate, Vorchheimer says. “This should be 100%,” he argues. “People are perfectly capable of opting out. If they don’t opt out, they’ll be well on their way to contributing the minimum 10% needed to reach retirement income adequacy.”
While auto enrollment and auto escalation are the best means of encouraging greater retirement savings by employees, some companies are going further. For instance, Intel, which had $46 billion in revenue last year, augmented its auto enrollment plan for new employees with a re-enrollment feature for the rest of its workforce. “We targeted thousands of employees who were not contributing to their 401(k) plans and supported them with education and counseling as to why this was in their best interests,” says Stuart Odell, Intel’s assistant treasurer for retirement investments. The effort paid off, with 50% of the non-contributing group enrolling.
Gables Residential, an Atlanta-based real estate developer of primarily multi-family apartment complexes, tried a different tack. “We had about a 43% participation rate in our 401(k) plan in 2008,” notes Philip Altschuler, the company’s senior vice president of human resources. “At the time, we had 1,300 employees, and the economy was headed south. People were concerned about their finances and held back [from participating in the plan].”
This didn’t square with Gables’ mission, “Taking Care of the Way People Live,” Altschuler explains. So the company brought in its 401(k) plan provider, MassMutual, to help hike the participation rate. “We hosted a health benefits fair where employees could get free biometric screenings, flu shots, cholesterol checks and the like,” Altschuler says. “At the fair, we provided each employee a ‘Passport to Health,’ which looked like a real passport. On the last pages where the stamps are, we offered $10 off their insurance premiums if they spent a few minutes with MassMutual’s retirement education specialists.”
After employees listened to a presentation by the provider, the participation rate skyrocketed to 72% from 47%. After a similar campaign last year, the rate is now 85%. Last year’s effort also included educating employees on the need to increase their savings rates, and the average rate rose to 6% from 4%
State Street’s Mitchem cites another novel way to encourage a higher savings rate—a financial fitness “boot camp.” Like a real boot camp, employees would commit to a defined period of pain, but it’s financial not physical. “The idea is to auto enroll employees in the plan at a 10% savings rate for six months to determine if they can handle this financially,” she says.
Although the concept has yet to be implemented, State Street and Boston Research Group surveyed 1,000 plan participants about their willingness to try it. A startling 75% said they would take part in a boot camp if their employers offered one. “More employees are willing to take direction from their employers simply because of their anxiety about ongoing volatility in the financial markets,” Mitchem says. “Once they know the facts, they apparently want employers to force them to take action.”
Other ways to promote better retirement outcomes include dissuading employees from taking hardship loans from their plan savings. “People think because it is largely their money in the first place that there’s nothing wrong with borrowing from it,” says Madrian. “If there is indeed a true hardship that requires immediate access to money, that’s one thing. But all too often employees borrow from their savings to do things like pay for a vacation or buy a new car.”
Another problem with such loans can occur when an employee with a loan is fired or voluntarily leaves the company. “Most companies require that the loan be paid back to the plan within 30 days,” says Madrian. “Many employees can’t come up with the money, however, and end up defaulting. While this isn’t the same as defaulting on a bank loan, which would affect one’s credit rating, it’s still ‘leakage’—money taken out of the retirement savings system.”
While Shapiro says it is tough for employers to completely disallow hardship loans, he advises that sponsors limit loans to employees with certain reasons, like the imminent foreclosure of a house or funeral expenses for a family member. “Without such restrictions in place, plans will get sucked dry,” he says.
Cashing out is another event that empties the coffers of the retirement savings system. Roughly 30% of plan participants cash out their balance in a plan within two years of leaving a company, despite the tax ramifications and a 10% penalty for those below the age of 59 ½, Madrian says. “We did a survey of plan participants last summer where one of the questions we asked was whether they had cashed out their plan savings or taken a hardship loan, and did they regret this,” she adds. “Almost 60% said they did, even though it seemed like a good idea at the time.”
How can companies dissuade cash outs? Education seems to be the key. Before employees leave, Madrian advises having the company’s retirement adviser or plan provider sit down with them to discuss the potential ramifications. “You might be able to slap on a restriction that says you can cash out what you invested in the plan, but not the corporate match until you’re 59½,” she says. “I’m not sure of the legality of this, but it would be worthwhile to explore.”
The Harvard professor also would like to see plan sponsors make automatic contributions to the 401(k) plan that aren’t contingent on the employee’s contributing. “Most employers in the private sector put money into a plan only if the participant puts money into it—the traditional corporate match,” Madrian says. “But many universities like my own will put money into the plan without a corresponding amount contributed by the employee. There is nothing that says corporate America can’t do the same.”
Intel is doing just that. “We make a contribution to all of our employees’ retirements regardless of whether the employee saves on their own,” says Intel’s Odell.
It may not be grandpa’s pension plan, but it’s a step in the right direction.
For an earlier look at ways to boost workers’ savings in retirement plans, see Cheers for 401(k) Tiers.