We know Americans don’t save enough for old age, and the latest data always remind us how bad it is.
An oft-cited metric is that one-third of all American families have saved nothing at all for retirement, and the median savings for all families is a mere $5,000.
Here’s my concern: We hear this data all the time, and we’ve heard it for years. But no one really does anything to stop it.
But, it turns out that if you look across how companies are structuring plans, you can find that there are a couple of things that actually work. The closest thing I’ve seen to a magic elixir to get Americans saving is if plan sponsors offer two things in tandem: automatic enrollment in 401(k) plans, and individualized financial education.
It may sound extreme, but it’s both legal and effective: Employers can automatically enroll eligible employees in 401(k) plans, perhaps starting with a 3% contribution and automatically increasing that by 1 percentage point annually up to 10% annually. Employees can have the choice of opting out, but such plans will get more employees starting saving for retirement earlier. That’s hugely important because many people simply set their savings level once and then keep it for life. The average person needs to save 20-times annual living expenses for a comfortable retirement. Someone that wants $50,000 annually in retirement, should save $1 million. Someone wanting $150,000 each year, should save $3 million. Making contributions automatic can be added to a plan at any point by the plan sponsor.
But the data show that this change, on its own, may not do it. Employees are known to cash out their retirement savings between jobs, or some may decide to opt out if they don’t have a comprehensive view of how 401(k) accounts and financial planning work.
If employees aren’t saving enough, offering personalized, expert financial advice will help raise awareness of the urgency of the situation. Individuals need coaching tailored to their own situation. A millennial paying off student loans, or a parent of a child going to college, may not have the best information about their own particular situation and may dig into their retirement savings in a pinch. It’s the worst thing you can do: It’s like running around picking up nickels in front a steam roller. You might get some quick cash, but it can be devastating in the long-run. In the industry, we call this leakage.
A study by the Center for Retirement Research at Boston College found that employees take money out at a high rate for hardships or after the age of 59-1/2, or cash out plans when individuals leave a job. The report found that leakage runs at about 1.5% of assets annually and can reduce a person’s retirement wealth by as much as 25%.
These two items – automatic enrollment and coaching — will go far to actually change the tide. If every company did this, we might solve the retirement crisis.
Once these are in place, there are other elements of strong retirement plan configuration that can also help:
1. Make advice accessible
Once individual coaching is in place, information about the employee’s plan should be available across platforms, including classroom seminars, one-on-one meetings, a smart phone app and a website.
2. Simplify your plan
Employees would also be likely to understand plans better, and contribute more, if they had fewer investment options. Employees are overwhelmed by having too many options and slimming down those options by offering such things as target date funds and funds that reflect lifestyle choices increases participation and contributions. Research from Columbia University and The Vanguard Center for Retirement Research reveals that every additional 10 investment choices on average in a retirement plan cuts participation rates by 2%. Adding a robo-adviser component to make investment choices easier for participants can also help boost participation.
3. Change compensation structure
A more radical solution is changing the way employees are paid to “force” retirement savings, putting some compensation in a 401(k) while lowering their salary by the same amount. For example, instead of a worker earning $75,000 with a 3% 401(k) contribution (for total comp of $77,250), the employer could pay that same worker $68,400 with a 13% contribution (for total comp of $77,292). The difference to the employee’s retirement nest egg would be huge. However, every employer needs to understand if lower salaries will make them non-competitive in their market.
4. Spread out employer contributions
Many employers match employee 401(k) contributions dollar-for-dollar — for example, matching contributions up to 3% —and as a result, many workers will contribute only that amount. If employers matched contributions at 50 cents on the dollar for 6% of contributions, it would cost the same amount but more employees would be likely to contribute 6%.
5. Consider adding annuity options
Most 401(k)s today pay a lump sum on retirement. Plan sponsors should consider adding an annuity option upon retirement, giving employees the option to receive a set amount of money every year until death. Annuities are more popular among millennials than any other generation, according to a survey by the Indexed Annuity Leadership Council, suggesting that adding an annuity option would increase participation.
What’s in this for the business? With the job market heating up, it helps retain employees and recruit key talent. The other reason: The next time you read about the retirement crisis in America, you can sleep easy knowing that you really have given your employees the best shot possible at making it to a good retirement.
Michael Krucker is a senior consulting manager with Plante Moran’s employee benefits consulting practice.