-David Bronstein, chess grandmaster and tactical genius.
Two quick practices to get and keep employees savingA good plan sponsor should be focused on designing and implementing a retirement plan that creates successful outcomes for employee participants. Part of that design includes features that help participants save more, remove barriers to participation, simplify decision making and accommodate specific preferences. Over 25 years of anecdotal evidence and the more recent mountain of behavioral finance research continues to highlight that participants know they need to save for retirement but fall prey to inertia. Inertia is defined as: a tendency to do nothing or to remain unchanged. When plan sponsors let their employees make enrollment and savings decisions the sponsor will struggle with lower participation rates and even lower average savings rates. This is due to financial inertia. Does that sound like a plan that is going to create successful outcomes for participants? I don’t think so.
There are at least two design features that plan sponsors can use to get employees in the plan and help them save more. But often they do not use these. They are auto enrollment and auto escalation.
Getting employees to participate in the plan is the most critical function for a plan sponsor. Savings rates and investment options are important, but if an employee never enrolls in the plan, all other issues related to the plan are moot. A plan sponsor should look to make the enrollment process as easy as possible and eliminate the hurdles that inhibit participation. Instead of requiring employees to complete and return enrollment forms or log on to a new website to complete online forms, automatic enrollment provisions allow plan sponsors to enroll every eligible employee automatically. The employee is enrolled utilizing a default deferral percentage and default investment alternative, both of which are defined in the plan document. Any employee who does not wish to participate can opt out or change default elections at any time. By reversing the enrollment process, making employees opt out instead of opt in, plan sponsors will see higher participation, will potentially increase initial savings’ rates, and most importantly encourage good savings behavior.
While automatic enrollment helps get employees in the plan, automatic escalation addresses the issue of participants not saving enough. The overwhelming majority of participants never change their deferral percentage or investment elections after the initial enrollment. Some studies place that number as high as 80%. Most participants grossly underestimate the amount of savings required to maintain their standard of living in retirement and instead base their amount of savings on the employer match. Even participants who know they need to save more find it difficult to save on their own. Automatic escalation addresses this issue by increasing participants’ contributions by a preset percentage, 1% for example, each year. This way the participants’ contributions grow without excessively impacting their take home pay. Notices distributed each year before the increase give participants the opportunity to change or opt out of the escalation.
Many times plan sponsors initially react negatively to the suggestion of making automatic decisions for employees when it comes to their paycheck and savings. But participant surveys tell us the following:
Participants know they need to save for retirement and know they likely need to save more, but they are looking for help. While auto features are not a “magic bullet,” used appropriately, they leverage participant inertia. This movement, once started, will promote and encourage good savings behavior, which should lead to more successful outcomes for participants.
Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor. Member
FINRA/SIPC.