Taking It a Step Further

It’s a thing of beauty—a defined contribution (DC) retirement plan with 100% participation and a high average salary deferral rate. A rare specimen to be sure, says Ken Hoffman, of the HSW Advisors team at consulting firm HighTower in New York City, but it is not an impossibility. He says one way to get there, or anywhere close to 100% participation, is by implementing automatic enrollment.

“One client in particular comes to mind that we’ve set up with the ‘auto’ features,” Hoffman says. “It’s a small plan, but it has a lot of assets and both a defined contribution and a defined benefit [DB] part to it. When the plan changed advisers and brought us on board, it was actually structured as a commingled trust for everyone who was participating in what we felt should have been a 401(k) plan.”

Uncomfortable with the trust arrangement, Hoffman’s team first re-enrolled the eligible defined contribution population into a newly created 401(k) plan. It has been a number of years since the re-enrollment, he says, but the participation rate has stuck at 100% among eligible employees. Another factor in the continuing success was the timely introduction of a line of risk-based portfolio models that provide automatic diversification and rebalancing for participants. The portfolio models have quickly gained popularity among both long-time plan participants and new enrollees, Hoffman says. Participants are given a risk-tolerance assessment to identify the appropriate portfolio, taking into consideration factors such as salary, outside assets, outstanding debts and the projected retirement date. The exercise helps participants “think in the bigger terms of risk and return,” he says. 

“As you know, the stock market has been strong in recent years, and many of our participants tested into moderately aggressive portfolios, so that has also been helpful,” Hoffman says. “Our new participants have experienced exciting growth. When we come in the door for quarterly meetings, they tell us they’ve checked their balances and they’re feeling great. People feel ownership over these accounts and they are invigorated.”

Hoffman says this example tells us a lot about the intersection of psychology and finance, and a little bit about the chicken and the egg, too. He says it is important for the adviser and his sponsor clients to put themselves into the shoes of an eligible nonparticipant. When a potential participant is not enrolled in a plan, he has no balance to look at, Hoffman notes. His only experience with the retirement plan is perhaps fleeting guilt about neglecting to participate, or simply confusion about what the 401(k) plan is and how to join it.

“With no balance to look at and no direct responsibility for that balance, retirement readiness in turn becomes a very amorphous and faraway concept,” he contends. “In decades past, employees looked to their old-time defined benefit plans and they thought, ‘My corporation is going to take care of me.’ And they didn’t have to think much more about it.”

Today’s DC-centric workplace retirement savings programs, wherein the individual worker saddles far more responsibility for achieving retirement readiness, require new engagement strategies, Hoffman says. One of the main jobs for advisers and sponsors is to kick-start engagement—likely via automatic enrollment and re-enrollment. Other tools are equally important, he adds, such as auto-escalation, through which a participant’s annual salary deferral percentage is bumped up by 1% or 2% each year, usually to a cap between 10% and 15%.

Lisa Jungers, a principal of Retirement Benefits Group (RBG) in San Diego, agrees that automatic features are a bridge to retirement security for vulnerable Americans. In addition to being a member of her firm’s client service team, Jungers also personally services about 24 401(k) plans of different sizes.

Like Hoffman, Jungers has a wealth of examples to cite where automatic plan features have notably increased plan participation rates or deferral percentages, but she points to one case that is particularly compelling because it bucks many assumed limits of auto features. The plan is run by a large restaurant chain in the U.S. that has about 130 locations and 6,200 total employees, 4,700 of whom are eligible to participate in the 401(k) plan. As with many plans operating in the service and retail industry, workers must put in 1,000 hours before they can open a plan account, Jungers says, due to high turnover in the work force.

“I think, in general, our industry’s view has been that auto-enrollment doesn’t work for retail, in part because of the turnover concerns,” she says. “In fact, many of our other retail clients are still really resisting the auto features, so we have to push them toward safe harbor plan designs.”

Jungers says her firm won this restaurant chain’s business in the spring of 2011. At that point, participation among eligible employees was a stark 4.9%. Jungers and Hoffman say the average 401(k) participation rate in the U.S. for eligible workers is far higher than that—somewhere in the ballpark of 75% or 80%. The 2013 PLANSPONSOR Defined Contribution Survey shows that the overall average participation rate in employer-sponsored DC plans among eligible employees is 76.9%.

“So the plan was in really terrible shape from [the] perspective [of participation],” Jungers says. “Part of the problem was there was no employer match incentive to get people to jump into the plan. Management had to remove the match during the 2008 crisis, as so many companies did, and they hadn’t reinstated it yet.”

Interestingly, the lack of an employer match actually made the job of implementing automatic enrollment somewhat easier, Jungers says. “They didn’t have the increased match costs to worry about with the auto features,” she explains. “With large plans and small plans both, that can really be a significant increase in expenses. We’re still working with them to find a way to reinstate the match, because that’s going to be another big way to help their employees reach retirement readiness.”

Even without the match costs to consider, management at the restaurant chain continued to delay making any plan design changes through May 2012, when Jungers brought an in-depth analysis and benchmarking study to the plan officials. She laid out the poor participation figures in a host of compelling exhibits and arguments, making the case that a plan with 4.9% participation was not supporting anybody—neither the employer nor the employees.

“One thing that really helped was that the recordkeeper was able to promise there would be no fee increase—because, remember, auto-enrollment will lead to a lot of small balance accounts at the beginning,” she says.

This promise from the recordkeeper made a huge difference to management, Jungers says, and by late 2013 and early this year she was working with the sponsor and other plan fiduciaries to write automatic enrollment provisions into the plan’s operating documents. Participation rates had started to pick up earlier because of more concerted educational efforts, but once automatic enrollment was put in place, participation quickly soared—from about 6.2% to 90.8%, Jungers says, where it stands today.

The plan automatically enrolled 2,927 employees at a starting deferral rate of 3%—Jungers had pushed for a higher percentage—and out of that number only a single employee subsequently decreased his deferral rate to 1%. Another 147 employees, or about 5% of those who were auto-enrolled, went on to opt out of the plan entirely. Based on this plan’s successes, Jungers encourages advisers who implement auto-enrollment to push the recordkeeper for a promise to keep fees the same. Advisers should also ask about the extent to which the recordkeeper would be willing to handle some or even all of the required notices coming out of substantial plan design changes, as compliance concerns are often cited by reluctant employers.

“Yes, it took three years of work and conversations to get the plan to go with auto-enroll,” Jungers says, “but the payoff has absolutely been worth it. We were also able to convince them to do auto-escalation as well, at 1% per year to a 6% cap. They wanted to come back and make that change later, but we convinced them it’s better to make these design changes together. You don’t want to be going back every year and making major changes to the plan documents.”

Jungers says auto-escalation features are critical for helping participants achieve retirement readiness within plans that do not feature an employer matching contribution—and within plans that auto-enroll participants at an annual salary deferral rate of 6% or less. According to the PLANSPONSOR Defined Contribution Survey, about 82% of plans with auto-enrollment set the default deferral below 6%, often as low as 3% or 2%. As Jungers points out, it typically takes a deferral rate near 10% to achieve even a small measure of retirement security from defined contribution plan assets. 

Other options exist for sponsors to help push up client deferral rates, she adds. For instance, sponsors can consider “stretching” the employer match, which entails making smaller match payments per dollar deferred by participants while allowing the match payments to apply to higher percentages of salary. In other words, rather than match 50% of the first 6% of salary deferred, the employer could match 25% of the first 12% participants contribute. This strategy results in similar costs to the employer while also motivating a higher deferral rate from the employee.

“Research shows people don’t often change their deferral percentage after auto-enrollment—or regular enrollment for that matter,” Jungers says. “If you put them in at 3%, or 6%, they’ll stay there. So, looking at my clients, eight of our plans have auto-enroll, but not all of those have auto-escalate. Two or three don’t have auto-deferral increase provisions, and it has a real impact on outcomes.”

Hoffman has seen many cases where clients thought their employees could not afford to be auto-enrolled or auto-escalated—causing the plan to resist automatic features. In these situations, it is critical to remind the sponsor client that auto-enrollment and auto-escalation always come with an opt-out feature. It often becomes easier for even lower-wage employees to save if dollars are diverted directly from the paycheck, he says, and the hit on take-home pay is frequently less than expected.

“You’re not forcing your employees to do anything besides check a box that says, ‘I don’t want to participate at this time,’” Hoffman says.