Quite a few retirement plan experts have recently said that 401(k) retirement plans have been a huge mistake for most Americans. As evidence they point to many studies that have been published which show that none of us are saving anything near what is necessary to fund our retirements. How can our 401(k) plans be improved so that there is a better chance we are able to retire and receive reasonable benefits someday? Consider the following:
- Mandatory employee contributions. Studies have shown that more than 80% of participants who are auto-enrolled (typically at a 3% contribution rate) in 401(k) plans do not opt out. Using employee inertia in a positive way by auto-enrolling all employees (existing and new) is one way to boost contributions quickly.
- Auto-escalation of contributions. Similarly, those auto-enrollment plans which have an auto-escalation component also have very few participants who opt out of contributing more. Auto-escalation of 1% per year up to a contribution rate between 10% and 15% is normal.
- Require employer contributions. Most 401(k) plans were never meant to be standalone retirement plans but instead were designed to be paired with a defined benefit pension plan. Many employers that eliminated their pension plans pledged a certain level of contributions to their 401(k) plans (3% was common). During economic downturns, many employers stepped back from their 401(k) plan contribution commitments. Requiring employer contributions of 3% would not be unreasonable.
- Protect employees from themselves. Having worked with retirement plan participants for over 25 years, I can tell you with a high degree of confidence that the second biggest reason that participant balances aren't large enough is because of bad participant investment decision-making. The majority of participants in 401(k) plans sell out of equities at the bottom of markets and buy in at the top. Require the use of target date funds or managed accounts for participants having balances below a certain level (e.g., $100,000).
- Outlaw participant loans. One of the worst investment decisions anyone can make is to take a participant loan. The interest isn't tax deductible (like a home equity loan) and loan proceeds are double-taxed (loan payments are made from after-tax earnings and loan proceeds are taxed again when withdrawn at retirement). Many participant loans are defaulted (incurring an early distribution penalty tax of 10%) permanently removing the funds from use for a participants retirement.
The 401(k) plan concept is a good one. However, it might be time for legislators to step in and nudge participants in the right direction.
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). Mr. Lawton may be contacted at firstname.lastname@example.org or 414.828.4015.
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