Previewing Plan Features
Art by Spencer Ashely
U.S. employers continue to seek improvements to their defined contribution plan designs. According to a February WTW survey, 75% of DC plan sponsors had made a change to their plan beyond swapping out a fund in the previous two years and expected to make at least one more change over the next two years. Twenty-eight percent expected to adjust their plan’s automatic deferral features, and 38% intended to adopt an innovative contribution strategy. Other possible changes such as allowing employees to use their contributions to pay down student loans or to build emergency savings are also being considered.
The motivation to make plan design changes can come from either the adviser or the sponsor.
Shannon Maloney, managing director with Strategic Retirement Partners in Northville, Michigan, says, 95% of the time, it is her firm initiating discussions with the sponsor over potential changes.
In contrast, Neal Stamper, corporate retirement director with Morgan Stanley’s Graystone Consulting in Atlanta, says sponsors frequently provide the initial idea by telling their plan adviser what challenges they are experiencing and what problems they are trying to solve. “When we have a clear understanding of the client’s needs, we can bring options that fit with what the client is trying to accomplish,” Stamper says. “That’s what I see most often.”
Design Changes Being Considered
Stamper says he is seeing increased interest in student loan repayment programs and how companies can help their workforce in that area. He says, as companies see the success of features such as automatic enrollment and automatic escalation, which have helped participants get more involved with their benefits, those employers see the potential of other benefits such as student loan repayment.
Comparing the client with its industry peers can bring to light new features that could be added to the plan, Maloney says. She cites the possibility of adding a Roth option to a plan, offering in-plan Roth conversions and auto-enrolling employees into the Roth option. The sponsor would then need to consider what parts of the workforce it will auto-enroll—all participants, or just new employees? she says, noting that the same question applies to auto-escalation provisions.
Further potential design changes include allowing partial withdrawals and installment withdrawals, particularly as retirees evaluate the potential benefits of leaving their funds in the employer’s plan, Maloney says. “Other plan design topics we’ve considered, as well, include looking at the match, stretching the match and profit-sharing,” she says. “Those are things we’re always talking about.”
The Need for Modeling
Adding plan features is like adding options to a new car: They can improve the ownership experience, but they usually increase the cost. Matt Compton, managing director, retirement solutions with Brio Benefits Consulting Inc. in New York City, says his firm is a “huge advocate” of most automated features, which, he says, have had the most positive impact on plan participants and participation rates. But he stresses that sponsors need to understand the auto-features’ possible financial impact. “If the company is offering a match, it needs to be very much aware of how adding automatic enrollment may affect its financial commitment to the plan, moving forward,” he says.
That is where modeling comes in, Compton says. He explains that Brio Benefits tries to ensure it gives employers the maximum out-of-pocket expense they could expect “if we get the plan firing on all cylinders.”
“Take a plan that has a 60% or 70% participation rate, and we successfully add automatic enrollment,” he says. “Now, all of a sudden, we drive participation up to 95% or 98% over the first few months after making those types of changes. That’s going to have a significant financial impact on the employer. We need to make sure it’s aware of what that will look like.”
Stamper also emphasizes the need for careful pre-change cost analysis. It is easy to get excited about implementing changes, he says, but the potential costs cannot be overlooked. “The finance side of the company may come back and say, ‘Wait a minute, let’s think about this, because implementing these automatic programs may cost significant matching dollars,’” Stamper says. “So that’s the other side of it. Yes, we all want the plans to be more successful and for more people to participate. But communicating the potential corresponding costs to the company is critical as well.”
Adding plan features is like adding options to a new car: They can improve the ownership experience, but they usually increase the cost.
Seeking a Safe Harbor
To model changes in very small plans is relatively simple because of the low participant count, but forecasting revisions in larger plans is potentially daunting. Maloney cites the example of a new client that started working with her firm last fall. When the sponsor signed on with SRP, the plan provided a 50% match up to 6% of compensation, but the company’s highly compensated employees all were getting refunds of excess contributions, which was a source of discontent with that group.
In addition, employee turnover was high for the first few years after hiring but then dropped off considerably.
After examining the plan, SRP asked why the company was not using a qualified automatic contribution arrangement safe harbor plan. The response, Maloney says, was that the plan sponsor was unaware of the QACA safe harbor provisions. SRP developed a model that illustrated how the plan would increase to a 100% match on the first 1% of compensation, which would raise the total match outlay to 3.5% of the first 6% of compensation, vs. 50% of 6% compensation for a 3% total cost.
SRP also recommended a vesting schedule change from the company’s four-year—i.e., increasing by 25% a year—schedule to two-year cliff vesting. “We calculated what its match was currently, what it could be, and then what the return on investment was, based upon having the two-year vesting schedule that would be added,” she says.
The employer, which Maloney describes as “very paternalistic,” decided to use the two-year vesting schedule with new hires while letting employees on the four-year schedule finish it out. The QACA safe harbor arrangement also solved the excess contribution problem for highly compensated employees and provided recruiting and retention benefits.
“The [client] was able to [stand] out, in a market where it’s trying to aggressively attract and retain employees, by saying it increased its match,” Maloney says. “And it was able to give them definitive proof that it’s doing more than other companies in its industry, so that if someone were to leave to go to a competitor around the corner, it could stand pretty firm and say [the employee] wouldn’t be able to receive the same kind of benefit package at the other employer.”
Stamper points to an example of modeling a plan in which the company recognizes the need to maintain a competitive benefits program but also wants to avoid increasing the plan’s matching cost. “If the finance team says, ‘We don’t want to spend any more than we’re spending today on the match,’ one option would be to stretch the matching formula,” Stamper says.
For example, if the current match is dollar for dollar up to 3%, the company could change the matching formula to 25 cents on the dollar up to 12%. “If the participant then changes their deferral to 12%, they’re putting in more dollars, but the dollar amount of the company outlay will be the same, because the math has changed on the match,” Stamper says. “Match stretching is one way that companies have tried to encourage participants to contribute more while keeping company contributions relatively consistent.”
Stamper offers another modeling scenario based on matching tiers. In these plans, the base match remains the same, but the employer creates a second matching tier to motivate participants’ behavior. “[The sponsor] may consider keeping the dollar-for-dollar up-to-3% base match but will add a tier so it matches $0.10 on the dollar for the next 7% of eligible compensation, with the goal of getting the participant to save 10%,” Stamper says. “It adds a sweetener to the matching formula so participants are less likely to feel something was taken from them in a change to the base match.”
Number Crunching
It is easy to explain, and for sponsor clients to grasp, the concepts behind model changes such as these, but the proposals and their projected costs must meet multiple departments’, and the plan board’s, approval. “We have to bring it back to the fact that we always have three bosses,” Maloney observes.
First, she says, the human resources staff will be looking out for employees’ well-being, and it wants the plan to attract and retain quality employees. Second, finance will be considering the budget and asking about the return on investment for any proposed expenditures.
“And third, we look at it from the CEO’s or the board’s perspective to make sure we’re not adding any risk to the company or to its capital by having these plans,” Maloney says. “Have we done everything from a fiduciary perspective to reduce, mitigate or eliminate risk that could be in the retirement plan?”
The decision about proposed design changes will likely hinge on the anticipated impact they would have on participant behavior and the plan’s costs. In the previous example, SRP staff developed a “very large” spreadsheet that included data on 3,000 employees’ hire dates and current match. Using that data, the firm forecasted the proposed match cost and extrapolated it, based on the company’s turnover, to develop an ROI estimate.
“It’s just a lot of number-crunching,” Maloney says. “We have one person doing all the work, and we have a peer review where a couple of us check it over. Then we compare all that data with industry data—we usually get our industry data from Franklin Templeton, because it receives the PLANSPONSOR industry reports.”
An adviser with no in-house staff, or with none to utilize for model development, may seek partners to assist with the work. Compton’s firm is not a third-party administrator, he says, but it works closely with its TPA-partners to keep its participant census data current. With that information, Brio Consulting can create Excel spreadsheets to build the models.
Stamper, too, has had good experience with TPAs and recordkeepers helping with plan design change calculations, he says. In his experience, it is helpful to leverage existing partners and the tools they have, to develop different scenarios. “Then, once the numbers are back, it’s a matter of facilitating the conversation and discussing priorities,” he says. “We may go back to these providers and ask them to tweak some of the scenarios based on the priorities of the client.”