8 strategies to maximize DC retirement plans
February 21, 2013 1:37 PM
1. Decide between offering a retirement or savings plan
Is your DC plan a Savings or Retirement program? Many plans have the word retirement in their name, but operate more like a savings plan: employees put aside balances they can tap during their careers to address temporary income shortfalls or high-cost life events. However, if you see the programs goal as helping employees plan and actually save for a secure retirement, then new strategies may be in order. For example, you may now want to default employees to much higher contribution rates than the current norm of 3% or 4%. If you realistically believe the organization can only offer a savings vehicle, then educate employees that they are largely expected to look out for their own retirement income needs.
2. Revisit matching contribution threshold
Conventional wisdom suggests employees need to save around 15% of pay to retire at age 65 with adequate resources, according to Aon Hewitt. But many employer-match contribution formulas dont encourage employees to reach this target. Under a typical formula for an employer with only a defined contribution program, a plan provides 3% of pay as a non-elective contribution, with a matching contribution of 50% up to 6% of pay. Assuming the employee elects to contribute the default 6%, this produces total contributions of 12% of pay (6% employee + 3% non-elective + 3% match).
Think your employees cant afford to save more than 6% of pay? Research shows that many take their cue from the plan design on how much to save, and would thus increase their contributions. To encourage them to contribute more, consider a formula of 33% up to 9% of pay: this produces total contributions of 15% (9% employee + 3% non-elective + 3% match).
Matching a higher percentage of pay beyond 6% isn't a safe-harbor design for purposes of avoiding Average Contribution Percentage (ACP) testing. And some sponsors in low wage industries may believe its impracticable to raise the match threshold. But these concerns shouldn't end the discussion of considering the 15% savings target in future design/redesign discussions.
3. Focus on Designated Roth contributions
With higher income and investment tax rates now a reality, you might want to adopt Designated Roth Contribution provisions in the plan. You should also be sure to communicate its potential benefits, and offer to help participants with decision support or modeling tools. Consider implementing the recently enacted liberalized rules for converting any plan balance to a Roth account. Many administration and technical issues need to be addressed before these can go live, but what we know for sure is that the plan will need to offer current Designated Roth Contribution accounts.
4. Use Health Savings Accounts as a retirement savings tool
A couple could need $400,000 to be highly confident of affording their post-age 65 out-of-pocket medical expenses, finds the Employee Benefit Research Institute. This doesn't include long-term care expenses. So it may be time to offer a high-deductible health plan and show employees how saving through an HSA may be a tax-efficient way to pre-fund these expenses. The tax benefit is better than qualified retirement plans and IRAs because no taxation applies to funds (used for medical purposes) as they go in, as they accrue investment income, and as they come out.
5. Add projected retirement income estimates to participant statements
Personalized messages are the most effective communications about the importance of saving for retirement. Why not show, on each participants statement, the annual retirement income that their account balance would provide? Realizing that a $100,000 balance may only supply $400 of monthly income will help encourage savings.
6. Streamline the number of investment options
The human brain has a limited capacity to choose among different options: seven choices at most. Plans offering 30-40 investment options may only serve to confuse participants without really providing more choice. Most employees are unable to grasp the diversity of funds. Yet some sponsors still seem to be reluctant to reduce the number of funds for fear of offending the status quo. But limiting plan investment alleviates the problem of participant choice paralysis. It also helps the fiduciary prudently select and monitor all the investment options. (You may have to leave certain legacy funds in place pending expiration of any surrender or back-end sales charges, while allowing all new contributions to flow to a streamlined line-up.)
7. Review Target-date fund glide path
Target-date funds are taking an increasing share of new plan contributions, participants are willing to litigate at the first sign of significant losses, and new products have become available that claim to offer superior downside protection. Given these developments, a current review of the target date funds offered by the plan seems a critical component of fiduciary due diligence.
8. Understand how plan fees are allocated
Should fees be allocated on a per-head or a pro-rata (based on account balance) basis? Should only those participants investing in funds paying revenue-sharing bear the cost of plan recordkeeping, or should these costs be allocated across all participants? If the allocation of recordkeeping fees is changed, does this allow a plan to consider using non-revenue sharing funds such as Collective Trusts or a wider use of passive strategies not previously feasible? Fiduciaries need to understand and document how the fees are allocated as part of their oversight responsibility.
