10 key features of a retirement-ready 401(k)
As a 401(k) plan sponsor, you have no doubt embraced the concept of retirement readiness. Employee retirement readiness can best be defined as financially prepared employees able to retire without lowering their standard of living.
Employers have the responsibility to help their employees achieve retirement readiness by offering a 401(k) plan with features that guide participants down the right path. The following attributes are generally found in retirement-ready 401(k) plans.
1. Auto-enrollment: Automatic enrollment of all new participants at a default contribution percentage of at least 3%. Progressive employers are auto-enrolling at contribution rates closer to 6%. According to a 2017 JP Morgan survey of larger plans, 64% of employers have implemented auto-enrollment.
2. Auto-escalation: An annual automatic increase in participant contribution rates of 1% per year, typically up to a maximum of 10%. Based on a 2017 Callan survey, 63% of large 401(k) plans auto-escalate participant contributions.
3. Auto re-enrollment: Automatic re-enrollment each year of participants who opt out of initial enrollment at their time of hire or who stop contributing during the year. According to a 2017 T. Rowe Price survey of larger plans, 61% of employers either currently re-enroll or intend to adopt re-enrollment provisions in the near future.
The combined use of these three “auto” features generally results in plan participation rates in the low 90% range. These features also give participants a shot at attaining the annual contributions of 12% to 15% of gross pay that Vanguard and other experts recommend.
4. Tighter rules surrounding participant loans: Requirement of hardship withdrawal criteria in order to take a loan and/or reduction in the number of loans available in an effort to plug leakage. Fidelity advises that 50% of participants who have a loan also have at least one more. The odds that a loan will be paid back if a participant changes jobs are very low. In addition, 401(k) plan loans are terrible investments for participants.
5. Roth 401(k) availability: Retirement-ready 401(k) plans allow participants to make after-tax Roth 401(k) contributions. The Callan survey indicates that 68% of larger 401(k) plans offer Roth 401(k) contributions.
6. Stretched employer match: An employer match spread over a larger percentage of employee contributions. For example, 25% of the first 12% rather than the standard 50% of the first 6%. The goal of the stretched match is to encourage participants to contribute more so they can get closer to the 12% to 15% annual contribution target. According to the T. Rowe survey, 38% of large employers offer a stretch match.
7. Integration of 401(k) plan and financial wellness education: Most employers have recognized the link between financial wellness education and 401(k) plan education. Many believe that educating on basic financial concepts not only increases employees' understanding and appreciation of their benefits, but also helps them do their jobs better.
8. Lowest possible cost investment options: A mix of actively managed and index options that all use the lowest-cost share classes available.
9. Participant investment advice: According to the Callan survey, 83% of large 401(k) plan sponsors offer some sort of investment advice assistance to their participants.
10. Availability of target date funds: Fidelity reports that more than 45% of all participants have their entire 401(k) account balance in target date funds. The JP Morgan survey indicates that 62% of employers offer target date funds.
According to the T. Rowe survey, nearly 50% of employers use a metric to gauge retirement readiness. Most — 52% — use a metric that is provided by their recordkeeper. I expect the use of retirement readiness measurement tools to rise in the future.
How many of these retirement-ready features does your 401(k) plan have?
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC.