5 Ways to Make Your 401(k) Like a Pension

Over the past 30 years, employer-sponsors of retirement plans have moved away from offering pensions to offering 401(k) plans. This transition has given employees greater control over managing their financial lives.

However, the increased savings responsibility has become a challenge for many Americans eligible for a 401(k). Based on a survey of employers, only 15% felt confident with the average savings rate of their employees.2The research shows that many workers with 401(k) plans—when left to their own devices—are not contributing enough, often only the bare minimum to qualify for any matching funds from their employer.¹ Revising your 401(k) plan’s design and services to act like a pension can help overcome the detrimental inertia that inhibits employees from saving more.

Furthermore, nine out of ten of the employers did not feel satisfied with their employees’ knowledge regarding the amount they needed to save for an adequate retirement savings level. The 2017 Employee Financial Wellness Survey discovered that now only 49% of employees are comfortable about retiring when they want.3

Although you may not be able to offer a pension to your employees, you can still deliver some of its benefits with modifications to your 401(k)’s plan design and services. With these five 401(k) plan changes that make your plan mirror how a pension works, you can help your employees to more successfully manage their savings responsibility.

#1. Automatic enrollment

Pension plans do not require participants to make deferral elections or select funds. Similarly, by setting up automatic enrollment on your 401(k) with a default deferral rate, you can relieve your participants from having to take any action in order to benefit from a retirement savings plan.

Automatic enrollment has helped many plans increase participation in retirement saving. According to the Aon Hewitt 2016 Universe Bookmarks Report,4 which analyzes the retirement savings behavior of 3.5 million employees, participation in defined contribution plans with automatic enrollment was 86%. In contrast, participation in plans without automatic enrollment was 63%.5

However, automatic enrollment can have the unintended consequence of employees contributing less than would otherwise be inclined to contribute. It was recently found that while automatic enrollment increases participation rates, it also can lead to lower contribution rates when the default deferral rate is set to 3% or lower.6

Employers can prevent this risk by combing automatic enrollment with features like automatic deferral escalation and stretch-matching contributions.

#2. Automatic deferral escalation

To help prevent the automatic enrollment’s unintended consequence of reducing employee savings, employers can add automatic deferral escalation to their 401(k) plan design.

A pension plan requires an employer to contribute enough each year to ensure an adequate savings amount is being set aside for employees. Automatic escalation for 401(k) plans increases participant deferrals on a yearly basis to help ensure participants are saving enough for an adequate income in retirement. For example, an employee’s deferral rate can automatically increase 1% each year until it reaches a maximum percentage of their pay, typically 10%.

Furthermore, increases in 401(k) contributions can also be set to coincide with when pay employee increases, minimizing any reduction in pay. This can be a painless way for workers to increase the amount they save each pay period.6

#3 Stretch-matching contribution

With a stretch-matching contribution, employers can encourage employees to save for their retirement without increasing the overall employer matching contributions. The table below demonstrates how stretch-matching contribution formulas incentivize participating employees to increase their deferral rates.

STRETCH-MATCH FORMULA
FULL MATCH
UP TO 3% OF PAY
50% MATCH
UP TO 6% OF PAY
33% MATCH
UP TO 9% OF PAY
Employer contribution 3% 3% 3%
Employee minimum contribution
to maximize the employer match
3% 6% 9%
Total contribution 6% 9% 12%

In all three examples, the employer is committed to contributing 3% of pay to employees who defer. However, the more the match is stretched, the more employees are encouraged to increase their deferrals.

Through the combination of automatic enrollment, stretch matching and automatic increases, your goal is for employees to attain an 80% income replacement ratio at retirement. This combined approach also helps address the potential downside that comes with just offering automatic enrollment alone.

#4 Personalized Guidance

Pension plan sponsors are provided investment advice from investment advisors to optimize the plan’s performance. You should make advice available to your 401(k) participants in ways they can easily understand and access.

For example, you can choose a retirement plan provider that makes this advice understandable by presenting personalized recommendations to employees by their age and retirement goals. Furthermore, you can increase employee engagement with a provider that makes their account and educational information accessible on various devices, such as desktops, tablets and mobile devices.

#5. Target Date Funds

A pension plan’s asset portfolio is managed by the plan sponsor and their advisors to help create a diversified investment portfolio customized to the plan’s specific needs. Likewise, target date funds provide a professionally managed mix of stocks and bonds that are an automatically customized fund selection and asset allocation to the participant. Similar to a pension, participants do not need to worry about which funds to select and how much money to put in each. A target date fund will evolve as a participant ages to ensure the portfolio’s diversification is appropriate to the participant’s age.

Target Date Funds have become extremely popular for 401(k) plans and participants. The 2017 Investment Company Institute report notes that plans offering target date funds increased from 57% to 72% from 2006 to 2014. During the same years, participants holding target date funds increased from 19% to 48%.7

Conclusion

The research shows that many workers with 401(k) plans—when left to their own devices—are not contributing enough, often only the bare minimum to qualify for any matching funds from their employer.1 Revising your 401(k) plan’s design and services to act like a pension can help overcome the detrimental inertia that inhibits employees from saving more.

Nonetheless, the core feature of 401(k) plans—employee control—still remains. If an employee can't part with the salary that these features help them save, he or she can simply opt out.

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Is your 401(k) plan adequately helping your employees prepare for retirement?

1 Why some employers are becoming more generous with retirement savings plans, Chicago Tribune, August 10, 2017. 2 Hot Topics in Retirement and Financial Wellbeing, Aon Hewitt, 2017. 3 2017 Employee Financial Wellness Survey, PricewaterhouseCoopers, 2017. 4 2016 Universe Bookmarks Report, Aon Hewitt, 2016. 5 2015 Universe Bookmarks Report, Aon Hewitt, 2015. 6 How Auto-Escalation Can Help You Save More for Retirement, U.S. News, January 27, 2016. 7 2017 Investment Company Factbook, 2017.