May 25, 2017
In general, 401(k)s are not living up to their promises. Yes, they do provide a tax-advantaged means to equity ownership for millions of American workers. But too many workers are not fully participating in market gains, and too much capital is being siphoned away from workers’ accounts by various inefficiencies and middlemen.
That’s the conclusion of Falling Short: The Coming Retirement Crisis and What to Do About It, by Charles Ellis (author of Winning the Loser’s Game), Alicia Munnell and Andrew Eschtruth. Munnell and Eschtruth are the Director and Associate Director of Boston College’s Center for Retirement Research, respectively. If their projections hold up, today’s crop of workers are not going to retire with anything near the financial security their parents and grandparents had.
Consider: According to research from Transamerica, the average 401(k) participant is contributing about 3 percent of compensation each year. That’s nowhere near adequate to support a reasonable retirement lifestyle for most workers given current projected rates of return.
That’s a tragedy. But there are some steps employers can take that will help unlock the potential of the 401(k) plan for their own workers. 15th Annual Transamerica Retirement Survey has a number of specific recommendations.
Use ‘opt out’ enrollment. With this approach the default should be inclusion in the plan until an employee makes a deliberate effort to get out of it. The employee is informed that, say, 2 or 3 percent of his or her income will be withheld, tax-deferred, and contributed to the company retirement plan. “Automatic 401Ks still allow an individual the opportunity to say, ‘No, I really didn’t want to be in the plan,’ but this approach is a proven success at improving participation rates,” says Eschtruth.
For better results, Eschtruth suggests combining escalating contributions. That is, the plan is set up so that contribution levels gradually increase. The Transamerica survey found that employees are generally willing to go along up to as much as 7 percent of compensation.
Reach out to part-timers. At present, only 49 percent of plan sponsors surveyed extend 401(k) benefits to part-time workers. Many of these workers are making do by combining two or more part-time jobs, but if they cannot contribute to a plan they are essentially locked out of a major source of financial security in retirement. If they cannot save now, society will be paying a price in the future.
Consider the Roth Option. Many plans have added a Roth option for their employees in their retirement accounts. With the Roth IRA, the worker funds the retirement account with after-tax dollars, but gains unlimited tax-free growth in the future. The Roth is a great deal for younger workers because their tax rates will be presumably lower now than they will be in the future as they reach their peak earning years. They also have many years of growth ahead of them. Roth accounts are not subjected to required minimum distributions, which makes them that much more attractive.
Offer ‘target-date’ funds. An annual investor survey by a financial services research firm known as DALBAR finds, year after year, that individual investors routinely underperform the markets by a wide margin. They are, in the aggregate, simply poor investment decision makers who tend too often to buy high and sell low. Plan sponsors can help mitigate this problem by offering funds designed for ‘buy and hold’ investors, such as target date funds and asset allocation funds with modest expenses.