401(k) redesign requires clarity, focus on financial literacy

Just like employees are known for their “set it and forget it” attitude, many employers have gotten complacent about their defined contribution retirement plans. If there are no problems with their current plan, many just leave it alone and never go back and take a bigger picture look at what they are offering.

But with still- recent fee disclosure rules in place and talk of a new fiduciary definition being batted around, employers have had to become savvy when it comes to the management of their retirement plans. There also have been a number of class action lawsuits regarding high plan fees and fiduciary responsibility, including the recent Tibble v. Edison International case, which the Supreme Court heard at the end of February.

Also see: 401(k) suits draw employee attention to fees, fiduciary duty

In their deliberation, the Justices seemed to agree that Edison should have done a better job of overseeing its investments to make sure participants weren’t overspending on retail class shares when lower cost institutional shares were available. More importantly, the case is supposed to decide when participants can sue an employer over certain investments within the plan. Under the Employee Retirement Income Security Act, they have a six-year window to file a suit after the investments have been chosen. The lower courts determined Tibble could not sue over high fees attached to three investments in the plan because those investments had been chosen more than six years prior.

The mission

Designing the ultimate defined contribution plan isn’t just about the investments chosen to be in the plan. It is about strategy, a company’s mission and core values and the demographics of the workers being served by the plan.

So where should employers start when looking to revamp their 401(k), 403(b) or 457 plan?

Also see: Retirement planning a ‘significant hurdle’ for employees

Employers need to first be clear on why they are sponsoring a retirement plan. Many want to attract the best workers by offering great benefits. Others care about the financial wellness of their employees, realizing that employees who are stressed about their finances will carry that burden into the job with them. Another segment is concerned about retirement readiness. If older, higher paid workers stay in the workforce longer because they haven’t saved enough for retirement it costs companies money to keep them on the books, particularly through increased health care and disability insurance costs.

“The major focus for us is strategic planning; developing a strategy and game plan to help the company develop the best plan possible based on the values of the organization,” said Alex Assaley, principal at AFS 401(k) Retirement Services, LLC, a company that helps employers with their DC retirement plans.

“Instead of reviewing investments, participation in the plan or savings rates, which are all very important, let’s step back and think about why we have this plan. Determine if the plan’s structure today meets who we are today and want to be tomorrow,” Assaley said.

Also see: 9 hot trends for DC plans for 2015

Most companies create a mission and vision statement and expect all aspects of their business to fall in that mission, including sales, service and internal culture.

“Many companies stop there and don’t tend to look toward the structure of their benefits and think holistically around how their benefits shape the employee experience and define the culture of the organization,” Assaley said.

“It is important that the entire retirement process be looked at: human capital goals, workforce planning and a total rewards system,” he added. “Retirement is a piece of the total reward.”

Retirement readiness is another prime objective of a retirement plan, which has implications in terms of plan design and investment options, said Dagmar Nikles, leader of the investment strategy team for BlackRock’s U.S. and Canada Defined Contribution Group.

Also see: In-plan guaranteed income products growing in popularity

Savings, the amount of money put into the plan, the investments and the cost of the plan all figure in to that retirement readiness piece. Workforce demographics also play a major role in DC plan design.

“Someone who has been with the organization for a while and has a defined benefit pension plan has a different need to save than someone just starting out in the workforce and has never been eligible for a pension,” said Carolyn Wood, director of retirement for Bimbo Bakeries USA in Philadelphia, Penn. – a nationwide food service company with 14,000-plus participants and nearly $900 million in assets in its 401(k) plan. “That really is one of the changes in the way lots of organizations are looking at things now, how to design programs for different segments of the population because it is not a one-size-fits-all approach.”

New features

Bimbo has worked closely with Fidelity the past couple of years to redesign the company’s 401(k) plans. The company implemented a full suite of automatic features, including auto enrollment, auto escalation and auto rebalancing, after the company grew with a major acquisition in 2012. The objective was to get higher participation rates in the plans, which it did, Wood said.

Also see: U.S. retirement assets reach $24.7 trillion

“The greatest force in business in the universe is inertia. Once something is in motion, it tends to stay in motion. Once you get someone to start contributing, generally they will continue to contribute,” said Pirie McIndoe, vice president and defined contribution director at Sibson Consulting.

Automatic features are key, said Nikles, but many companies don’t use them to their full potential.

“Two out of three plans are using auto enrollment but typically it is only used for new participants joining a plan,” she said. Some of BlackRock’s clients have begun applying auto enrollment to participants who previously opted out of the plan and to others who are saving below the current default contribution. Both options are helping to get employees into the plan.

Also see: How to benchmark a DC plan

When planning their retirement plan investment menu, many companies use a tiered approach. Tier 1 is a default option, like a target-date fund, a managed account that rebalances into less risky investments as a participant nears retirement age.

Tier 2 is the core investment lineup. The newest trend in tier 2 is to simplify and reduce the number of investment options available. Ten to 15 years ago, employers thought that having more choices was better.

“We know from behavioral research that is not the case,” said Nikles. “Put too much choice in front of participants and they get confused and it causes inaction.”

Tier 3 is a managed account, where employees have the ability to choose what they want to invest in, for a higher fee. According to a June 2014 report by the Government Accountability Office, fees can range from $8 to $100 on every $10,000 of investable assets.

Also see: Employees lack knowledge to optimize Social Security benefits

If businesses can get employees to begin contributing at an early age, they will see a benefit, said McIndoe. He pointed out that those early contributions, along with employer matches and compounded interest, make up the bulk of the assets available to participants upon retirement. More than half of the wealth that comes in comes in during the last 10 years before retirement, he said, primarily on the underlying accumulation an employee created by the time they turned 55.

Bimbo is working with Fidelity to implement an easy enroll program that uses anchoring to get employees to not only opt in to their retirement plan but to do so at a higher allocation rate than the typical 3 percent. Easy enroll gives employees three allocation choices: 6%, 8% or 10%.

Research shows that when given a choice, employees will typically choose the lowest allocation available, Wood said. Bimbo wants to make sure that employees who use this one-click easy option are opting in at a higher rate immediately.

Investments 

Many companies have turned to qualified default investment alternatives to help employees who don’t know anything about investing save for retirement. The default investment of choice has been the target-date fund.

Also see: Choose TDF first, then recordkeeper

There has been some controversy surrounding the risk associated with target-date funds.

“The fact is most assets in TDFs are there by default by people who don’t understand investing at all,” said Ron Surz, president of Target Date Solutions in San Clemente, Calif. “They are in there because they don’t understand. The people who should understand but seem not to are plan sponsors and fiduciaries and their advisers.”

Surz fears the TDF industry will experience another setback as it did when the stock market dropped in 2008. That was when investors realized that money they thought was invested safely in conservative investments through TDFs was actually invested in risky options, even when the holders of those accounts were nearing or at retirement age.

“The number one objective should be to not lose participants’ money, especially near the target-date,” Surz said. He said that the ultimate goal of TDFs right now seems to be replacing pay and managing longevity risk, “but there’s no glide path in the world that can do this. Those objectives are best met by saving enough. Basically they are saying we will take you to Vegas to make up for people not saving enough. It is not a smart move.”

Also see: New 401(k) plan participants drive TDF growth

Bimbo’s investment committee understands that there can be problems with these types of managed accounts.

“We worked with our legal counsel and determined the appropriate risk with that. We feel it does require a significant amount of due diligence because it is a default option and the most popular option,” Wood said. The company moved to index funds for all of its target-date options.

Alternative investments, like commodities and real estate, and fixed income options also can have a place in a company’s retirement plan investment menu, said Nikles. In this low interest rate environment, many companies have reevaluated their fixed income exposure, especially since the “nice returns people received over the last 20 or 30 years may not continue in the future,” she said.

Plan sponsors are also looking at their active and index exposures. “There’s a focus on getting the appropriate amount of active and index strategies within the plan,” Nikles said.

Financial education and wellness

One of Bimbo’s main focuses in 2015 is to look at factors that affect how people are using their retirement plans, Wood said.

The company evaluated the financial literacy and financial wellness of its employees to look for strategies that would help them achieve retirement success.

Also see: 401(k) access key to positive retirement outcomes

“What’s the impact of financial stress at work for our associates; how does a person’s financial wellness affect their ability to save for retirement; and how are they making those decisions?” Wood said. “We’re looking at those strategic concepts, in conjunction with a targeted communication and education approach.”

The key is engagement, she added. “I think there are great options out there for participants. Get them engaged in the plan,” Wood said. “I think that really the key to defined contribution is awareness and financial literacy and then the engagement and participation.”

Dennis Sawyers, senior human resources and benefits consultant at the American Society of Hematology, meets with the organization’s financial adviser on a quarterly basis to review fund performance and talk strategy. ASH’s core focus is on wellness, he said, and, for ASH, wellness encompasses more than physical and emotional fitness. It also includes financial fitness. The organization looks at its population demographics and considers the different life events that people are experiencing based on their gender and age. It then tailors communications to those different groups.

Also see: Lack of understanding hinders IRA contributions

For younger, unmarried employees, the organization’s financial management seminars focus on maximizing retirement savings before they have significant responsibilities, Sawyers said. For those who are growing a family or getting married, the organization speaks to them about building families, planning for marriage and a first home purchase.

The most important topic is “a strong and deliberate message that encourages people to fully participate in the retirement plan,” he said.

Laura Patton, director of human resources for the Mortgage Bankers Association in Washington, D.C., said that her organization has stuck with the same retirement plan provider since the 1980s but has made periodic changes to the 401(k) plan. It added in auto enrollment and annual automatic increases and began holding pre-retirement education sessions for people 45 years and older.

The topics include estate planning and wills, budgeting, Social Security and Medicare and financial planning 101, she said.

In 2015, the organization hopes to implement an all-staff financial wellness initiative that targets the company’s general population, not just those nearing retirement.

Also see: Improving plan selection through demographics

“I’m looking forward to seeing how it goes when we open it up to younger staff who may not be as focused on where they want to be down the line. I hope they take advantage of it,” Patton said.

Retirement income

Bimbo is in the initial phase of adding one more piece to its retirement puzzle and that is a focus on how to turn accumulated wealth into retirement income.

The company looks at employee behavior, metrics and plan utilization.

“The goal is to see how effectively our participants are using our plan options,” Wood said.

Retirement income is tied to financial wellness and literacy. Wood added that people need to figure out what their retirement income needs are going to be, including health care, and then it is up to the employer to give them the tools to do modeling and projections. Helping them understand the entire picture.

Also see: Workers willing to give up raises in exchange for secure retirement income

Nikles said she sees a lot of interest in how plan participants can turn the money saved in their DC plans into retirement income.

“I think it is early days here, but definitely we at BlackRock have been thinking about that for a number of years now,” she said.

The company gets many questions from plan sponsors who are not just thinking about the accumulation phase but are also talking about decumulation.

“There’s a number of choices. Part can be education and tools to provide participants perspective into drawdown strategies. It could also be an investment solution that provides an income in retirement,” Nikles said.

Employee benefits managers need to jump through many hoops to host a defined contribution plan, including ever-changing regulatory hoops. But in the end, most employers seem willing to take on the challenge because it is in their best interest and in the best interest of their employees.

Also see: Industry pressing the case for income solutions for DC plans

In the future, the automatic features that are just now coming into vogue will be commonplace and other options will evolve. Financial education, retirement readiness and retirement income seem to be the next frontiers for defined contribution plans moving forward.