It's clear that the advent of automatic features in defined contribution plans has had a positive impact, driving retirement readiness by boosting participation and savings rates, especially among workers newer to the job.
In fact, 73% of large and megaplans use auto-features, such as auto-enrollment and auto-escalation, to encourage greater savings in the defined contribution plan, according to Retirement Markets 2014, a report by Cerulli Associates Inc. Through automatically enrolling new hires in the plan, and directing them to the qualified default investment alternative option, preferably with at least a 6% deferral rate to start, employees are not only able to save for retirement but also can do so within an appropriately allocated investment vehicle that matches their specific retirement needs or time horizon.
While these advances are promising, it's become clear that two employee segments have been significantly left out of the impact of auto-features, affecting their chance for retirement savings success:
nActive plan participants hired before auto-enrollment and increased auto-deferral rates, resulting in a potentially misallocated investment strategy that might not meet their future needs, a low plan account balance and/or no ongoing contributions.
nNon-participating eligible employees hired before auto-enrollment, who chose not to participate in the plan, and are missing out on an impactful retirement savings tool (and potential match) altogether.
Providing access to all employees to engage in the plan, through re-enrollment, can have a significant impact on the success of the plan's objectives. In addition, it can be a powerful lever in helping employees achieve the retirement income they need to face ever-increasing age expectancy and accompanying health-care costs in retirement.
Re-enrollment is not only a benefit for employees; when done correctly, plan sponsors can strengthen their fiduciary standing by gaining sought-after safe harbor protections through the Pension Protection Act of 2006.
Through re-enrollment, the combination of auto-features and other savings incentives, such as a matching contribution, chosen by the plan sponsor creates a “choice architecture” for employees' retirement savings decisions, with increasing behavioral economics literature documenting that these plan design choices can have large effects on savings behavior, according to a July 2015 paper by two New York University academics and one Clemson University academic.
This choice architecture, in turn, leads to an increase in a participant's probability of success in reaching optimal income replacement levels in retirement. For the best outcomes, the default rate should be at least set to 6% to get employees saving at the minimum amount necessary to accumulate meaningful retirement savings. Also, 6% coincides with the rate necessary for participants to maximize a typical safe-harbor employer match.
Plan sponsors can, by working with their record keeper, access data on their plan's assets and participant allocations and then, working with the plan's adviser, can assess/determine if participants' assets are allocated properly — or, more likely for self-directed participants, improperly — for their time horizon. Plan sponsors can address key risk indicators, including: Are too many pre-retirees in all-equity portfolios or 20-somethings in just bonds and cash? Is a relatively risky investment option overweighted for the participant demographics? A re-enrollment campaign can help significantly to bring poorly constructed portfolios in line toward a more diversified and effective investment strategy through the QDIA default.
The Cerulli report shows among mega and large defined contribution plan sponsors, dramatic changes — for the better — in the average employee's portfolio diversification after re-enrollment:
At one plan sponsor before re-enrollment, the equity allocation across participants was random at best, with some 25-year-olds having no equity exposure and some 63-year-olds with 100% of their 401(k) assets in equities.
A plan re-enrollment was used to fix what this plan sponsor saw as an important problem by redirecting assets into the plan's QDIA. After re-enrollment, assets in the plan's QDIA, a target-date strategy, increased to 67% of plan assets from 17%.
In addition to helping direct participants into more diversified retirement portfolios, re-enrollment can be used to reduce employees' reliance on company stock.
While re-enrollment has had a slow start, the adoption rate is increasing as more plan sponsors gain an understanding of the benefits. According to a 2014 survey of plan sponsors by the Defined Contribution Institutional Investors Association, 15% of defined contribution plans overall have utilized re-enrollment. Larger plans were more likely to have engaged in re-enrollment vs. smaller plans. Some 19% of plans with more than $200 million in assets and 17% of plans of more than $1 billion re-enrolled participants, while 11% of plans with less than $5 million did so A 2015 survey of defined contribution trends by Callan Associates Inc.'s Callan Investments Institute cited the biggest reasons for re-enrollment as changes in the fund lineup and a concern about participants' poor investment selections.
More plan sponsors should be considering a re-enrollment strategy. Without it, the likelihood of their employees' ability to generate retirement income they won't outlive — and the potential impact on a company's bottom line through employees who can't afford to retire — is at risk. In order to increase the adoption rate of re-enrollment significantly, defined contribution plan sponsors need a better understanding of the benefits of an in-plan re-enrollment, the process and requirements to potentially gain fiduciary safe-harbor protection, and the mechanics and timing of proper implementation. n
Mark R. Browne is New York-based head of institutional and retirement marketing and retirement insights at BNY Mellon Investment Management.