Compounding Employee Savings
Plan design features such as automatic enrollment and the offering of life-cycle funds can encourage your faculty and staff to boost their retirement investments.
By Karla Hignite
When it comes to encouraging employees to save for their retirement and assisting them in the process, a multifaceted strategy would seem much better than any single design component implemented on its own to ensure retirement readiness.
That's according to research by the Employee Benefit Research Institute on plan design enhancements. These include features such as automatic enrollment and automatic contribution escalation, and offering target-date funds—also known as life-cycle funds—which are designed to offer a diversified portfolio that automatically rebalances based on an investor's age to focus more on income over time. Each of these plan variables can help participants accrue greater savings. Combined, they can compound those savings significantly, particularly for younger workers. Read "Draw Them In" in the April 2013 issue of Business Officer magazine.
For instance, while increasing the maximum level of employee contributions allowed by the plan sponsor (e.g., 6, 9, 12 and 15 percent of compensation) may have the greatest effect on boosting savings, including one or more of these additional factors can more than double the impact of the contribution limit only:
- Where you set the allowable annual increase in contributions (e.g., 1 percent versus 2 percent of compensation).
- Whether employees must opt out of the automatic escalation in contributions.
- Whether employees are able to retain their previous level of contributions when they change jobs versus reverting to the plan's default contribution.
When all four factors are applied, the probability of achieving sufficient income replacement in retirement increases for the lowest-income quartile of employees from about 46 percent to 79 percent, and from 27 percent to 64 percent among the highest-income quartile. (See "The Impact of Auto-enrollment and Automatic Contribution Escalation on Retirement Income Adequacy.")
The incorporation of target-date fund options in retirement portfolios is likewise proving attractive to a growing segment of employees who are looking for a straightforward approach to diversifying their investments. According to the EBRI/ICI (Investment Company Institute) database of employer-sponsored 401(k) plans—representing 24 million 401(k) plan participants in more than 64,000 plans—at year-end 2011, nearly three-quarters (72 percent) of 401(k) plans offered target-date funds as part of their investment lineup. These funds were held by 39 percent of plan participants and accounted for 13 percent of total plan assets.
That's a significant uptick from the 57 percent of plans offering target-date fund options at year-end 2006 and the 19 percent of plan participants invested in the funds, which accounted for 5 percent of total plan assets. (See "401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.") These funds appear to be especially attractive to younger hires. According to the study, at year-end 2011, 40 percent of the account balances of recently hired participants in their 20s were invested in target-date funds, compared with only 16 percent at year-end 2006.
Implementing specific plan components intended to help employees boost their retirement readiness won't guarantee their success. Likewise, a concerted focus on plan design must not replace an equally strong commitment to employee education. Yet, in the push to prepare your current workforce for a financially healthy future, every part of plan design should be carefully considered to maximize the impact of the benefit.
KARLA HIGNITE, Middletown, Rhode Island, is a contributing editor for Business Officer.