How to fix common 401(k) mistakes
With the rise of behavioral finance, more companies are electing to automatically enroll employees into their 401(k) plans and invest participants’ balances into default investments. If constructed and communicated properly, the default option will be deemed a Qualified Default Investment Alternative (QDIA), which relieves the employer of liability for losses and provides participants an appropriate long-term investment for their retirement savings. Plans with automatic enrollment help participants overcome inertia and are extremely beneficial for employees to achieve their retirement goals.
However, employers should also consider how they can best help employees who have made their own 401(k) elections or who have opted out of the plan. Are their contributions and investments appropriate?
Two plan design features — re-enrollment and re-solicitation — can correct what are potentially costly behaviors and strengthen retirement outcomes for employees.
For example, a 60-year old female worker who started contributing 20 years ago might have initially chosen to invest 100% in equities. This allocation may have been appropriate back then, but her allocation should be more balanced now to better manage risk as she nears retirement.
Meanwhile, a 25-year-old male employee may have opted out of auto-enrollment because he does not feel he is currently able to contribute to the plan. With 40+ years until retirement, younger workers often think they have plenty of time to save and don’t consider the lost opportunity for investment growth on even small contributions.
Both of these scenarios can create an issue for employees because they may not be contributing or investing appropriately for their situations. Re-enrollment and re-solicitation can solve these problems.
A retirement savings refresh
Re-enrollment is the process where participants’ accounts are automatically invested in the plan’s QDIA each year. Participants who do not wish to have their investments moved can opt out of the re-enrollment.
Re-solicitation impacts employees who are not currently contributing. An annual re-solicitation automatically enrolls all eligible employees and invests their contributions into the QDIA, unless they opt out.
These practices benefit employees because they provide an annual reminder for participants to review their contribution levels and/or investments. These plan design features also benefit plan sponsors. When a structured process is followed, it can mitigate concerns about employees not saving enough and/or investing appropriately for a meaningful retirement.
What steps should plan sponsors take to decide if they should offer re-enrollment or re-solicitation?
First, an analysis should be conducted to review the plan’s overall participation levels and savings rates, and how participants’ balances are invested. Is there a need for re-solicitation because participation is low? Are there too many near-retirees in all equity portfolios or young employees in a majority of fixed income options? Have participants selected multiple target date funds, which is not how they are designed to be used? A re-enrollment feature can help correct these investment allocation issues.
If a company is considering re-solicitation, they should also run a cost analysis to determine if there is room in the budget for any potential increased match contribution. Assuming most participants do not opt out, matching costs may likely go up if noncontributing participants are re-solicited each year.
If a company ultimately decides to adopt either feature, they should work closely with their advisors and 401(k) provider to determine what plan changes may be needed and the appropriate time to implement the annual “re” feature. Most plans run on the calendar year, so it often makes sense to implement them at the start of each year.
Once timing is determined, plan sponsors need to provide advance notice to participants and should communicate the changes 90 to 30 days before the re-enrollment or re-solicitation takes effect. Companies should also determine how these communications should be made. Do participants respond best with printed mailers or through email communications? Regardless, it’s best to send multiple communications as the “re” date approaches, so that employees don’t overlook the information and are not unexpectedly surprised by any changes to their account.
Re-enrollment and re-solicitation are very powerful tools that can go a long way to help employees accumulate a meaningful retirement portfolio. Employers should consider these options to help their employees towards retirement.