The media often use the term "retirement readiness" in discussions of whether retirement plan participants will be properly prepared for retirement at the end of their careers. There is no assurance that any 401(k) plan can place participants where they need to be when they wish to retire. Participation in these plans is voluntary, contribution levels are discretionary and investment management is the responsibility of the participant. So the best that a plan sponsor can do is suggest a way of participating and provide the tools for participants to construct a path to retirement that works for them. The following plan attributes have become associated with a 401(k) plan that is designed to help participants achieve retirement readiness:
Getting employees to participate:
- Automatic enrollment. To assure the participation of as many employees as possible, automatic enrollment in 401(k) plans has become a plan design standard.
- Default participant 401(k) contributions of at least 3%. It's not enough to enroll employees. In order for them to have a fighting chance at funding their retirements, they have to make contributions. A default 3% contribution rate has also become an industry standard.
- Participant 401(k) contribution auto-escalation. Participants need to average an annual contribution rate of between 13% and 15% into their 401(k) accounts throughout their careers to fund a retirement at a standard of living roughly equal to the level they are enjoying just before retirement. Automatic 401(k) contribution escalation allows participants to reach an appropriate level of contributions in a more or less painless way over time.
- A matching contribution. To incent participants to contribute, most companies provide at least a 3% matching contribution. Typically, this contribution is expressed as 50% of the first 6% of employee contributions.
Helping employees manage their account balances:
- QDIA. A Qualified Default Investment Alternative allows an employer to deposit participant contributions (without participant direction) into an investment option that will provide a reasonable rate of return over time with a good chance of beating inflation.
- Investment education. Participants are going to need help managing their balances. Annual investment education sessions with the option of talking with an expert one-on-one when needed has become standard.
- Online tools. The 401(k) world is do-it-yourself. In order for participants to succeed, they need to have access to a set of online planning tools that are easy to learn and use and comprehensive enough to permit planning, forecasting, risk assessment and investment research.
You may notice that five out of the seven standards outlined above take the power to manage a 401(k) account out of a participant's hands. Part of Retirement Readiness is protecting participants from themselves and using participant inertia in ways to benefit participants instead of penalize them. As a result, 401(k) plans that do not offer participant loans or withdrawal options prior to retirement will score higher on the Retirement Readiness scale.
Retirement readiness is an evolving concept that provides a helpful way of measuring whether an employer is offering a 401(k) plan that allows for participants to achieve their retirement goals. What should participants be doing to achieve Retirement Readiness? Please see the next post in this series for some answers.
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). He may be contacted at firstname.lastname@example.org or 414.828.4015.
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