IMPROVING PARTICIPANT OUTCOMES: AN ACTION PLAN FOR PLAN SPONSORS

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1 IMPROVING PARTICIPANT OUTCOMES: AN ACTION PLAN FOR PLAN SPONSORS By Carol A. Idone, CFP, AIF HANYS Benefit Services. All rights reserved. 1

2 Contents Intro 2 Changing Times 3 Participant Outcomes vs. Participation Rates 5 Steps to Achieve Results 6 Plan Options 7 Investment Menu Design 8 Advisory Help 8 Conclusion HANYS Benefit Services. All rights reserved. 1

3 A t year end 2012, approximately $5.1 trillion was invested in defined contribution retirement plans in the United States. 1 Approximately 42% of all private-sector workers participated in an employer-sponsored defined contribution plan in 2011, up from 29% just 25 years earlier. 2 These staggering numbers will only increase as the prevalence of private-sector defined benefit plans continues to decrease. Measured by sheer dollars, number of people affected, and growth in each of these metrics, it is clear that defined contribution plans are and will continue to be a mainstay in the market. But, are they working? Are they serving the purpose for which they are intended, i.e., are employees on target to meet their retirement income goal? If the intended purpose is not being met, what role should the plan sponsor play to effect change? This paper looks at some of the factors that plan sponsors should consider when assessing the value of the retirement plan offered to their employees and steps they can take to provide greater assurance that employees will be able to generate sufficient income for retirement. 1 Investment Company Institute, 2013 Investment Company Fact Book. 2 Employee Benefit Research Institute, Pension Plan Participation, , EBRI Fast Facts, no. 225, March 28, HANYS Benefit Services. All rights reserved.

4 Changing Times The days are gone when a typical employee works for the same employer for 30 or 40 years and then collects a check every month for the rest of his or her life. Although the majority of employees had little understanding of how a defined benefit plan worked, they knew exactly how much they would get each month at retirement. Together with what they would earn from Social Security, it was relatively easy to plan for the future. Through the defined benefit plan, employers played an active role in determining, or at least significantly influencing, the standard of living their employees would have in retirement. For the most part, there was little an employee could do, at least through his or her employer, to impact their retirement income. For many people, the combination of their pension plan and Social Security provided sufficient income for their retirement. The introduction of 401(k) plans in the early 1980s gave employers a retirement savings alternative to offer their employees. Although many 401(k) and similar defined contribution plans (403(b), 457(b)) were offered as a way for employees to supplement their retirement savings, such plans quickly became the dominant plan type in the private sector, far surpassing defined benefit plans Private Sector Workers Paticipating in an Employment Based Retirement Plan by Plan Type, (2) Defined Benefit Only Defined Contribution Only Both HANYS Benefit Services. All rights reserved. 3

5 With the shift in the types of plans being offered came a shift in the roles and responsibilities of the employer and the employee. Many employers still felt that the purpose of a retirement plan was to generate sufficient income to last through the employee s retirement years, but the majority of the decisions to make that happen shifted to the employee. Plan sponsors have always had a major role in the design and operation of 401(k) and similar defined contribution plans. Decisions on eligibility requirements, vesting schedules, contribution formulas, and other plan provisions were all the responsibility of the employer. In recent years, regulatory changes have placed even greater responsibility on plan sponsors, including heightened fiduciary responsibilities, fee disclosures, and expanded audit and reporting requirements. Although many of the changes that have occurred have contributed to an overall improvement in defined contribution plans, e.g., fee transparency, introduction of target date funds, etc., little has been done to ensure participants are any more prepared to retire. The 2013 Retirement Confidence Survey published by the Employee Benefit Research Institute shows that only 51% of workers are either very confident (13%) or somewhat confident (38%) they will have enough money to live comfortably in retirement. 3 These numbers have been decreasing steadily over time. Workers Confidence in Having Enough Money to Live Comfortably Throughout Their Retirement Years Very Somewhat Not Too Not At All Don't Know/Refused 100% 95% 90% 8% 17% 10% 85% 80% 19% 75% 70% 18% 19% 28% 65% 60% 21% 55% 50% 45% 40% 51% 41% 43% 35% 30% 38% 25% 20% 15% 10% 5% 21% 22% 27% 13% 0% 5% % 8% 15% 7% 6% 6% 6% 4% 20% Yearly 1% 0% 25% Change in 5% 5% 30% Not At All 11% 35% 1% 2% 4% 40% 7% 45% 9% 3% 3% 4% 4% 50% 55% 60% 65% Source: Employee Benefit Research Institute and Mathew Greenwald & Associates, Inc., Retirement Confidence Surveys Employee Benefit Research Institute, 2013 Retirement Confidence Survey: Perceived Savings Needs Outpace Reality for Many, EBRI Issue Brief, no. 384, March HANYS Benefit Services. All rights reserved.

6 More people are participating in employer-sponsored defined contribution plans but fewer people feel confident in their ability to retire comfortably. Factors contributing to this include: The market decline of 2008 significantly reduced retirement plan account balances. Current economic conditions have forced many employers to reduce or eliminate employer contributions; many employees have done the same. Despite decreasing unemployment rates, job uncertainty remains a concern for workers. Consumer debt is often identified as the most important financial priority, over and above saving for retirement. Uncertainties surrounding Social Security and health care coverage, including long-term care, place greater demands on employees ability to save for retirement. Clearly, these factors cannot be addressed solely by changing the structure of a 401(k) plan. However, in addition to the financial pressures of everyday living, another factor contributes to the lack of confidence that people have about retirement planning: they are simply overwhelmed about making retirement plan decisions. Many participants lack the confidence in their ability to manage their accounts. Others lack the desire and/or the time to make informed investment decisions. As a result, participants often make bad decisions resulting in bad outcomes. This is an area where plan sponsor involvement can impact outcomes, often at little or no increased cost to the employer. Participant Outcomes vs. Participation Rates Until recently, participant outcomes were not a great concern to most plan sponsors; even now, a relatively few number of plan sponsors use income replacement as a measure of plan success. A recent survey conducted by PLANSPONSOR magazine showed just 3.5% of plan sponsors use projected retirement income as a metric to assess their plans. 4 Instead, the goal was to offer a plan with good investment choices, competitive fees, and a recordkeeping platform that would minimize the administrative burden on the employer. Due to industry pressures and technology advances, the unbundling of these programs has driven down administrative costs and provided better choices to employees. However, the decisions of if and how to participate in the plan remain with the employee. The same factors contributing to lower administrative costs and improved investment selection also drove an increase in the complexity of the plan, at least as perceived by the employee. Although plans were now better, they did nothing to reduce the impact of participant inertia PLANSPONSOR Defined Contribution Survey HANYS Benefit Services. All rights reserved. 5

7 Certainly, plan sponsors have no obligation to help employees achieve their retirement goals. Yet, a recent survey conducted by Deloitte Consulting, LLC, showed that 62% of plan sponsors feel that our responsibility includes taking an interest in whether our employees are tracking towards a comfortable retirement. 5 Given this sentiment, there are several steps plan sponsors can initiate to improve the likelihood of retirement readiness for their employees. When asked, participants often say they want and need help in two areas of retirement planning: 1) how much to save and 2) how to invest their money. A growing percentage of participants would be more than happy to completely pass off their retirement planning to someone else to manage. A recent study by Aon Consulting found that participants should save 15% of their pay, including employer contributions, over their working career to provide adequate retirement income. 6 Such contribution levels, in conjunction with Social Security, would provide 85% pre-retirement income replacement, an amount considered sufficient to maintain the same standard of living in retirement. To the extent participants wait to enroll in the plan or enroll at lower contribution levels, the required contribution amount increases. In addition, often participants lack knowledge about making investment allocation decisions. Faced with an often confusing set of multiple investment options, participants often make investment decisions resulting in inadequate diversification and heightened risk exposure. Steps to Achieve Results Auto Everything The Pension Protection Act of 2006 established safe harbor rules under which employers could automatically enroll employees in a retirement plan at a specific deferral rate. This capitalizes on human inertia to effect positive savings habits. Surveys consistently show that plans with an auto-enrollment feature have higher participation rates compared to plans without such a feature participants simply do not opt out of the plan. However, the same inertia that makes auto-enrollment successful in getting employees into a plan can be counter-productive if other automated features are not added to the plan. If left to their own actions, participants will remain stuck at the initial default deferral rate, a rate often too low to generate sufficient savings. Some participants seem to employ faulty logic and conclude that the default rate set by the employer must be the appropriate savings rate and take no other action to change the contribution 5 Deloitte Consulting, LLC, Annual 401(k) Survey Retirement Readiness, 2010 Edition. 6 Aon Hewitt Consulting, The Real Deal 2012 Retirement Income Adequacy at Large Companies HANYS Benefit Services. All rights reserved.

8 amount. In some cases, the default rate may be even less than what a person would otherwise enroll at; lacking action on their part, these individuals are being hurt. An effective plan encompassing all automatic features will provide for auto-enrollment, a higher initial default rate, and auto-escalation. Assuming the 15% targeted savings rate as identified in the Aon study, a plan could be structured as follows: Auto-enroll at a default rate of 6% Auto-escalate provision of 2% annually Employer match of 50% up to 6% of salary The resulting employee/employer contribution levels are depicted below: Employee Employer Total Contribution Contribution Contribution Year 1 6% 3% 9% Year 2 8% 3% 11% Year 3 10% 3% 13% Year 4 12% 3% 15% The targeted savings rate is achieved in four years, far shorter than the average savings rate currently. To capture those employees who opt out of the program, an annual auto-re-enroll feature can be added. Plan Options Plan sponsors should review their current plan design features and consider how they drive participant behavior. Studies have shown that participants will often choose deferral rates at a level to obtain the maximum employer match. By stretching out the matching formula, the employer cost stays the same but the employee is encouraged to save more. For example, a plan that matches 100% on the first 5% could move to a 50% match on the first 10% of salary. The employer cost remains constant at 5% while at the same time employees are motivated to contribute up to the 10% level. It is important to limit participants ability to use the money for something other than its intended purpose: retirement. Plan sponsors should consider limiting, if not eliminating, loan availability within their plans HANYS Benefit Services. All rights reserved. 7

9 Participants rarely understand the true impact of taking a loan from their account borrowing from themselves is a common justification employees use. Although the current economic environment may not be the best time to eliminate loans, it should be something to consider for the future. Investment Menu Design As noted previously, many participants lack the ability, time, and/or desire to effectively make sound investment decisions and manage their accounts on an ongoing basis. Traditionally, many plan sponsors felt their responsibility was to offer a broad range of investment options together with employee education. The results, all too often, were that participants were overwhelmed with choice and rarely availed themselves of the education. In recent years, the trend has been to limit the number of investment options and guide participant behavior. The investment menu structure may be just as important as the actual investment options themselves. An effective menu design will address the various participant behaviors: Participant Behavior Do it for me Do it with me Do it myself Investment Type Target Date Funds/Risk Based Funds Core investment options that participants can use to build their own portfolio Self directed brokerage window allowing full flexibility in portfolio construction Properly done, a well designed investment menu can direct behaviors and give participants the confidence they need to feel comfortable with their investment decisions. Advisory Help Given the complexity, confusion, and lack of confidence that participants have relative to their retirement planning, it is not surprising that offering investment advisory help can significantly improve participant outcomes. Because different people learn in different ways, sponsors should consider offering advisory services in a variety of different ways to meet the needs of employees, including online investment advice, personal financial planning, and seminars HANYS Benefit Services. All rights reserved.

10 Conclusion Retirement planning and the roles that both the employer and employee play in it have and will continue to change. Although the employee remains primarily responsible for funding and managing his or her retirement account, the complexity of the decision making often leads to bad decisions and poor outcomes. Perhaps the biggest hindrance to improving participant outcomes is employee inertia. Most employees understand the need to save for retirement but lack the expertise, desire, and/or time to take the necessary steps to put a plan into place. However, the same inertia that prevents employees from taking action to enroll in a plan can be used to their ultimate advantage by preventing them from opting out of a plan if enrolled automatically. Plan sponsors have a fiduciary responsibility to ensure the investment options included in their plan are appropriate and the fees being paid are competitive. These actions go a long way to ensuring the plan being offered is a good one. However, the focus cannot just be on funds and fees. A lineup of five-star, low-cost funds becomes irrelevant if employees are not participating in the plan or are not making the right investment decisions. A well designed contribution formula combined with auto features can significantly improve participation rates as well as participant outcomes, often at little or no increase in cost. Plan sponsors can then take their plan from being good, to being one that works. About The Author Carol A. Idone, CFP, AIF, Vice President, HBS Carol has nearly 20 years of experience in the financial services and retirement planning market, having previously worked at The Hartford and AIG Valic. Carol holds her FINRA series 7, 24, and 63 licenses, is an Accredited Investment Fiduciary, and is also a Certified Financial Planner. If you have any questions about this paper, or would like to begin talking to a trusted advisor, then please get in touch by calling (800) or us at hbs@hanys.org. Visit us at Securities offered and sold through Healthcare Community Securities Corporation (HCSC), Member FINRA/SIPC, and a Registered Investment Advisor HANYS Benefit Services. All rights reserved. 9

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