NAFCU Services Blog

By Rich Rausser, SVP of Client Services, Pentegra

Retirement Readiness Begins with Progressive Plan Design

Ensuring successful participant outcomes begins with a retirement plan designed to maximize positive participant behaviors. Plan design features, including automatic features, can drive successful outcomes for participants and sponsors alike. Automatic features help participants on the path to creating an accumulation strategy for retirement income. Just as importantly, plan design is also integral to creating a path for participants to develop a decumulation strategy and plan for spending assets during retirement.

We’ve learned that plan design decisions are influential and can be a key driver in helping people achieve positive outcomes.

1.     Make It Easier to Participate

Our SmartPath™ advocates plan designs that encourage strong participation rates. Strong participation begins with eligibility features that make it easy for participants to take advantage of your plan—from day one. That means allowing for immediate eligibility. Keep in mind that this does not necessitate offering a matching contribution immediately to new hires, but immediate eligibility makes it easy to start payroll deductions and get employees into the habit of saving through the plan.

Action Items for Plan Sponsors

• Consider allowing for immediate eligibility to get employees enrolled in the plan right away and give them an “ownership” stake in their future.
• As a bonus, allow new hires to make rollover contributions to the plan and provide them an easy way to avoid spending lump sum distributions from a prior plan.

2.     Implement Automatic Features to Encourage Higher Savings Rates

When it comes to increasing savings, we have always advocated helping participants help themselves. Automatic enrollment ensures eligible participants will be automatically enrolled in their company’s 401(k) plan at a predetermined contribution rate unless they take action to opt out or choose an alternate contribution percentage. A primary advantage of auto-enrollment has been to get at least 90% of workers into a retirement savings plan. That is an impressive participation rate no matter how you look at it.

Typical automatic enrollment sets participants’ initial contributions at a minimum of 3% of their pay, increasing their contributions by 1% a year (up to 6%). While the 3% deferral rate is good, a 6% deferral rate is an even better starting point and what we recommend as a best practice. Using 6% of pay for automatic enrollment goes a long way toward increasing savings rates overall—in particular if your matching contribution is tied to a higher deferral rate. Doing so also enables senior executives and highly paid employees to save more by improving 401(k) non-discrimination test performance. Encouraging participants to save more by using an auto-escalation feature is another integral best practice. Auto-escalation of at least 1% per year, but preferably 2%, is ideal. By adding an auto-escalation feature to auto-enrollment at a 6% of pay level, within several years many employees will hit the all-important 10% of pay savings rate that we believe is crucial.

Action Items for Plan Sponsors

• Consider implementing automatic enrollment at a 6% of pay level, and auto-escalation of at least 1% per year, preferably 2%.
• While some question whether automatic enrollment is worth the cost of additional employer matching contributions, the rise in cost will often be modest—most higher paid employees sign up for a 401(k) plan on their own. It would make sense then that the population of employees that are automatically enrolled tend to have lower salaries. While every company needs to come to terms with this individually, more and more employers have determined that the benefits outweigh the incremental additional cost. Automatic enrollment can also make employees feel more secure and in turn improve morale and a company’s ability to attract and retain talent.
• Get creative with your matching contribution. Consider using employer matching contributions as another way to incent higher savings rates, and structure your matching formula to do so. Employees often contribute an amount that maximizes their matching contributions. Increasing the match cap will often result in higher deferral rates and ultimately, better retirement readiness.
• While the typical match of 50% on 6% is equal to 3% of pay, for nearly the same benefit dollars, you can use a 25% up to 12% of pay formula, or a 30% up to 10% of pay formula. Roll out the new formula in conjunction with a retirement education program to help employees see the value in making the most of the new match.

3.     Make Compliance Easier with a Safe Harbor Plan

Safe Harbor formulas provide alternative, simplified methods of meeting the non-discrimination requirements by offering certain minimum employer contribution formulas for 401(k) plans. Adopting a safe harbor 401(k) plan design allows an employer to avoid discrimination testing of employee elective deferrals and/or employer matching contributions (ADP/ACP testing).

Action Items for Plan Sponsors

• Consider adopting a safe harbor 401(k) plan design. Depending on your employee demographics and how your employees are using your plan, the Safe Harbor approach may be a good option to help avoid discrimination testing, allow highly compensated employees (HCEs) to maximize their contributions and ensure that the plan provides all employees with a base of retirement savings.

Stay tuned for Part 2 to learn more simple and effective tips for helping your members achieve retirement readiness.