401(k) Plan Design: Why it’s important to employees
According to research, most American workers are simply not saving enough for retirement. Employer-sponsored 401(k)s are the main retirement savings vehicle for most of us and are, essentially, voluntary.
There are lots of reasons why employees fail to take full advantage of these tax-preferred savings plans. In many cases, affordability is a real issue. Low income earners are often unable to save for the future because every dime is needed for today.
However, more often than not, good old-fashioned inertia is the culprit: “Never do today what you can put off till tomorrow.”
Behavioral Economics is the study of financial decision-making. It suggests that we prefer to spend rather than save, underestimate our financial needs, and overestimate our ability to cope with the realities of our future. (Who would have guessed?) Education plays a vital role in raising awareness of retirement planning, but plan design helps, too. Here are some plan design ideas that can make a huge difference to plan participation and employee outcomes:
Matching Contributions: Employees are more inclined to contribute to their plan if their employer is making a contribution, too. There’s a cost to the employer in doing this, but I would argue it’s nothing like the hidden cost of running a poorly-supported “benefit” program.
Auto-Enrollment. Make it easy to get into the plan. Automatically enrolling an employee in the plan improves overall long-term participation. Employees can choose to opt out, but most don’t.
Auto-Escalation: This design feature gradually, but automatically increases participants’ contributions each year up to a specified limit. Participants can always intervene and change this, but again, most don’t.
Target-Date Investments: Make it easy for employees to coordinate a retirement date with an age-appropriate, managed portfolio and/or default them into one at enrollment.
Thoughtful, deliberate plan design can help employees put more aside for their retirement by making participation easier and removing some of the guesswork. So why don’t more retirement plans implement these plan design changes? Maybe it comes back to inertia.