CAPTRUST Senior Director | Head of Professional Services
When assessing retirement savings behavior, we see that employees make and repeat several mistakes. They save too little, invest too conservatively — or too aggressively — and undermine their ability to accumulate retirement wealth in other, more subtle ways. But what about employers? Are they also making mistakes by failing to anticipate employee behavior? Or better yet, do they have opportunities to trump those employee mistakes? This article looks at the biggest mistakes employees make with their retirement savings and offers a few actions they may consider to help employees avoid them.
Mistake: Failure to enroll
Opportunity: Implement auto-enrollment
By far the biggest mistake many workers make is not getting into their plan as soon as they are eligible. In 2010, the Employee Benefit Research Institute (EBRI) analyzed the impact of automatic enrollment on the potential savings of employees between ages twenty-five and twenty-nine. Their research suggests that employees who are automatically enrolled could accumulate about five times their average earnings over the course of their career — versus less than one time average earnings under a voluntary enrollment system.1 Another positive by-product of auto-enrollment, for those who change jobs, is their ability to jumpstart their savings rate at a new employer. Over time, the impact of these seemingly small savings increases for employees in their twenties to mid-thirties can be dramatic.
Auto-enrollment also has a positive impact on participation. Employers who choose to automatically enroll employees see participation rates consistently above the 80 percent level according Deloitte’s Annual 401(k) Benchmarking Survey —with one in five plans auto-enrolling at 5 percent or higher. This demonstrates that automatic features not only get participants into plans but keep them there.2 Employees know that the act of starting to save is akin to starting an exercise program — the right thing to do but hard to execute while grappling with new responsibilities and numerous benefit decisions. Auto-enrollment keeps employees from languishing in a savings limbo and is viewed as an overwhelming positive by employees.3
Mistake: Saving too little
Opportunity: Pursue auto-escalation
Designing a plan to get employees on the right track for retirement requires employers to think not only about payroll-to-payroll employee deferrals but also how to move employees through careers that result in the ability to transition into the next phase of their lives. This means getting employees into the plan as soon as possible and saving at meaningful levels. For example, starting employee deferrals at 6 percent of income and escalating them to 12 or 15 percent over a few years using automatic increase features can help employees get to the kind of saving levels they need, depending on their ages.
In a follow-up to the 2010 research cited earlier, EBRI researchers performed additional analysis to study the impact of auto-escalation (in combination with auto-enrollment) on potential retirement savings. Their research findings indicated that, across the board, auto-escalation further increased accumulation up to 7.6 to 8.5 times final earnings for employees with more than thirty years of saving and investing in front of them.4 Offering an automated increase program is an easy remedy to consider and may even help with issues such as plan compliance testing.
Mistake: Poor investment decisions
Opportunity: Offer pre-diversified investment options
Assuming or expecting employees will make sound investment decisions could be detrimental to many of their portfolios. In fact, the hardest decision asked of employees when electing benefits is how to invest their retirement account. Many have neither the time nor the inclination to learn how to build their own retirement portfolios. However, this task can be simplified by offering pre-diversified options. Asset allocation models, risk-based portfolios, target date funds, and managed account services are all tools that can conveniently diversify their investments. Employers should also consider providing employees with learning opportunities or advice services in conjunction with these tools. This combination will help your employees invest well and put them on track for a more successful retirement.
Mistake: Chronic overuse of loans
Opportunity: Educate and limit number of loans
Access to retirement savings during employment through either loans or hardships is viewed to be a necessity by most employers. They want to alleviate employee fears about needing money in the event of an emergency by allowing them limited access to their savings. EBRI’s January 2014 research on loan activity indicates that about 87 percent of plans offer loans but only about 20 percent of employees use the feature; only a small percentage of loans end up in default.5 However, loans become problematic when the same population continually takes loans from the plan, often multiple loans for small amounts.
While the majority of employees with loans (81.7 percent) continue to contribute to their plan, loan interest costs erode their ability to accumulate.6 Further, employees with loans tend to defer at lower levels (6.2 percent of pay) than those without them (8.1 percent of pay).7 To compound the problem, many employers provide little or no education to employees about loans’ short- and long-term costs. Employers may consider providing access to loans while capping the number of loans an employee may have outstanding at any time and educate employees about borrowing costs and basic budgeting. These efforts could go a long way toward protecting employees’ retirement savings and may make them better savers.
The intersection of plan design and employee behavior provides a short list of powerful decisions that employers control and that may have a long-term impact on helping employees on the road to a successful retirement outcome. Consider the impact that your plan features can have on helping employees avoid mistakes and work with your CAPTRUST Financial Advisor to investigate options that may meet your needs.
1 Employee Benefit Research Institute, “The Impact of Automatic Enrollment in 401(k) Plans on Future Retirement Accumulations: A Simulation Study Based on Plan Design Modification of Large Plan Sponsors,” April 2010
2 Deloitte, “Annual 401(b) Benchmarking Study,” 2012
3 Defined Contribution Institutional Investment Association, “Plan Sponsor Survey: Structuring DC Plan Automatic Features to Pump Up Retirement Savings,” Issue Brief, March 2011
4 Employee Benefit Research Institute, “The Impact of Auto-enrollment and Automatic Contribution Escalation on Retirement Income Adequacy,” Issue Brief, November 2010
5 Employee Benefit Research Institute, “Many Have Access to 401(k) Loans, Few Have Outstanding Balances,” Fast Facts, January 2014
6 Aon Hewitt, “Leakage of Participants’ DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income,” 2011. p5