Over the 25 years that I've spent consulting with plan sponsors about their 401(k) retirement plans, I've noticed that the best plans have all or most of these seven attributes:
1. Low costs. This is a very important item for plan sponsors, especially since the Department of Labor has sent strong messages recently about managing costs. Most of the larger retirement plans we work with cost around 75 basis points (0.75%) or less, including the expense ratio of the funds, investment advisory fees, recordkeeping costs, trust and custody fees, employee education (materials and consultant) and employee communication costs.
2. Robust participations rates. For the plans we work with, those rates may be in the high 80% to low 90% ranges. The recent popularity of auto-enrollment features has helped boost participation rates in many plans. You should consider adding an auto-enrollment feature if your plan struggles with low participation.
3. High contribution rates. Plan participation has a couple of different definitions. A plan can have a high participation rate because the majority of the employees have an account balance. Participation can also be measured based on the percentage of employees who are actually contributing. In our experience, some of the best plans have a high percentage of employees making contributions (solidly in the 80% to 90% range) as well as a high percentage of employees who have account balances.
Both types of participation are worth a look since there are events that can distort the participation picture. For example, we observed that during the recent recession, many participants stopped contributing and have yet to start again. Because they have account balances, the plan may continue to appear to have a high participation rate. This can mask an employee education challenge. These participants need to start contributing again. Alliance Bernstein, in a 2008 study, calculated that if we are to retire and not lower our standard of living, we need to average 13.5% in contributions over our entire career. That contribution percentage rises significantly when participants stop contributing for a period of time.
4. Unique investment opportunities. The successful plans are successful for a reason. Many provide access to investment opportunities that may not be available anywhere else; thus, new employees roll money into the plan and departing employees leave it in. For example, a number of years ago I worked for a large life insurance company that offers a guaranteed rate fund in their 401(k) plan. Since the fund is subsidized by the company, it continues to pay over 6%, even in this low interest rate environment. What a deal!
5. High participant understanding. I have consulted on many different types and sizes of retirement plans during my career, and consequently I have talked to many retirement plan participants. The most successful 401(k) plans are well-understood by their plan participants. A lot of that is attributable to effective employee education. However, that needs to be coupled with an easy-to-understand plan design. If employees don't understand the plan, they won't contribute.
6. Diverse fund lineup. This is especially important in larger plans where a number of constituencies need to be considered. We believe that there are four types of retirement plan investors:
1. Core funds investors like to be well-diversified over the entire fund lineup.
2. Index fund investors want to invest predominately or exclusively in index funds.
3. Specialty investors look for unique investment opportunities to diversify his/her overall portfolio.
4. Accidental investors, who comprise the majority of your participants, don't want to spend any time with your plan and are probably most appropriately placed in target-date funds.
If your retirement plan is attempting to serve 1,000 or more employees, your investment menu may need to be broad enough for all of these investors to find a home.
7. Leadership support. All of the successful plans, without exception, receive significant support from their company's leadership team. These individuals don't only talk about the plan at official corporate gatherings; they use it as a recruiting and retention tool in their everyday conversations. For leadership to feel comfortable talking about the plan, they have to understand it. That requires a simple and straightforward plan design.
There are probably another seven attributes that successful retirement plans share, or even more; however, I have consistently found these seven to be the most important. How would you rate your plan on these seven items?
Contributing Editor Robert C. Lawton leads the Graystone Consulting retirement plan advisory group in Madison, Wis. Graystone Consulting is a business of Morgan Stanley Smith Barney and provides investment advisory services to corporations, not-for-profits, endowments and individuals. Lawton has more than 25 years of experience working with retirement plan sponsors and is an Accredited Investment Fiduciary and Chartered Retirement Plan Specialist. He holds Series 7, 31 and 66 licenses and may be contacted at email@example.com or 608-283-2304.
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