6 ways to build effective 401(k) plans
The head of Wells Fargo Institutional Retirement and Trust’s relationship management group identifies best practices for designing a company-sponsored 401(k) plan
Each day, my team works alongside thousands of employers to help millions of people — their employees — prepare for retirement. We’re like retirement coaches helping people get financially fit.
When it comes to physical fitness, there are the things we can control — what we eat and how much we exercise — and what’s not so easy to control: our genetics and aging bodies.
Likewise, when it comes to retirement fitness, plan sponsors who design 401(k) plans must know what they can and can’t change to best prepare employees for retirement. Our new Driving Plan Health report (PDF) may help you make these decisions; it highlights best practices based on five years of data (from 2011 to 2016) on the daily actions of 4 million retirement plan participants in every retirement plan we manage.
Other stories in this series
- Study: More workers are saving for retirement
- 6 things you can do today to boost your 401(k)
- How ready is your generation for retirement?
Here are some of the most important things you can do to build a well-designed retirement plan:
- Know your audience. Employee demographics matter when planning effective retirement plans. Employee savings behaviors vary by age, tenure, salary, turnover rates, and other factors. The more tenured an employee base, our research found, the higher the participation rates. We also saw that younger and less tenured employees are more likely to satisfy the diversification goal, possibly a result of being defaulted into their plan’s Qualified Default Investment Alternative.
- Establish specific goals for specific populations. Each group should have its own set of goals in three areas: participation, contribution, and diversification. For example, in an industry where turnover is high in the first years of employment — such as retail — you might offer voluntary enrollment based on the plan’s eligibility requirements and delay the automatic enrollment feature until an employee reaches a tenure milestone, such as one or two years of service. Our study shows that participation increases significantly once an employee has been at work between two and nine years. A company with less turnover and more tenured employees might, on the other hand, implement auto enrollment 30 days after employment begins.
- Take stock of where you are. As our report suggests, plan design matters but implementation matters more. Let’s assume, for instance, that one of your goals is to help employees maximize their deferral rate (the percentage amount they set aside from each paycheck) so that they’re saving at least 10 percent of income, including their employer’s match. We know that saving a minimum of 10 percent is ideal, and that beginning at an early age increases the odds of reaching that mark. So what do you do if a plan has mid-career and near-retirement employees who aren’t there yet? Perhaps you can start people at a higher deferral rate as a default (say 6 percent), and then utilize auto-contribution increase rates of 2 percent. That could help an employee get to 10 percent in only three years instead of eight!
- Make enrollment automatic for all employees. Participation eclipses 80 percent when retirement plans offer automatic enrollment. Consider enrolling all employees — including new and nonparticipating employees — at a 6 percent default deferral rate. That’s a best practice we’ve found that results in an average participation rate of 84 percent!
- Add “opt-out” to automatic increases. An opt-out feature means the employees must act to stop the percentage of their pay that goes to their 401(k) plan from automatically increasing every year. Using an opt-out function as a default, we’ve found, retains 79 percent of employees in the program.
- Provide more target date funds and managed savings options. Many participants struggle with adequate diversification on an ongoing basis. One way to address this problem is to include options like target date funds or managed accounts, which develop portfolios appropriate to the investor’s target retirement date. They also leave asset allocation and other management tasks to the pros, instead of participants.
Like any good fitness coach, we know that every step matters. We’re seeing plenty of hard work paying off, based on our Plan Health Index.SM This percentage score allows retirement plan sponsors to see how many of their employees are doing the three things that best predict a good retirement savings outcome: participating, contributing 10 percent or more (including the employer match), and having a diversified investment portfolio.
From 2011 to 2016, Plan Health is up 37 percent, meaning 37 percent more participants are more fit for retirement! That’s a trend worth celebrating.