In an era in which 401(k) plans have largely supplanted old fashioned pension plans, we hear ad nauseam that retirement is the employee’s responsibility.
But that doesn’t mean employers don’t have an important role to play. A new study by 401(k) administrator Principal Financial highlights several key ways in which employers can “entice participants” to save the 11% to 15% of salary per year that many advisers–including Principal–say is necessary.
One big problem: Currently, more than two-thirds of companies who automatically enroll workers in their 401(k) plans set contribution rates at 3% of salary or less, unless an employee chooses otherwise. Simple inertia takes over for many, who remain at that 3% “indefinitely,” according to Principal’s report.
One key solution, Principal says, is for employers to also “automatically escalate” those contributions, by raising employee savings rates by a set amount–typically, one percentage point a year–until they reach a certain threshold.
Another proposal (and one that gets relatively little attention) calls for restructuring employer matching contributions in ways that encourage greater savings. For example, rather than match 50% on savings of up to 4% of pay, Principal suggests “a match of 25% on deferrals of up to 8% of pay.” The cost to the employer, it adds, remains unchanged, “but the participant is enticed to defer twice as much.”
Principal’s other recommendations include:
- Automatically enrolling all non-participants every year. (Employees who are auto-enrolled can always drop out of the plan, although few do, according to Principal. “Automatic enrollment at 6% increased opt outs from the plan by just 4 percentage points over the 3% auto enrollment level.”)
- Raising default rates under auto-enrollment. “Nearly twice as many participants (61%) reach an overall savings rate greater than 11% when their employers’ plans default them to 6% versus 3% (32%).”
- Automatically enrolling participants in an auto-escalation program, rather than relying on them to enroll on their own. “Only 6% participate when this is a feature they have to choose,” the report says. “However 80% participate in the auto escalation feature when it is the default.”
The study says that plan sponsors believe employees should be saving an average of 12% of annual pay, and that those goals are more likely to be achieved with better designed 401(k) policies.