So, Are Defined Contribution (DC) Plans Effective?
There is no shortage of studies or surveys regarding this matter. Unfortunately, the results are not encouraging.
- 43% of workers are either “not too confident” or “not at all confident” about having enough money for a comfortable retirement The Employee Benefit Research Institute’s 2014 Retirement Confidence Survey
- 74% of Americans are “somewhat concerned” or “very concerned” that current economic conditions are affecting their ability to achieve a secure retirement National Institute on Retirement Security, March 2015
DC plans, in conjunction with social security and other savings, should enable individuals to accumulate enough savings to enable them to have a financially secure retirement. Why then, are survey results so discouraging?
Four poor choices made by DC plan participants are often cited as negatively impacting the participant’s ability to accumulate sufficient retirement savings:
- Eligible employees not participating in an available qualified plan.
- Eligible employees participate in a qualified plan, but do not save (contribute) enough.
- Participants make poor investment choices.
- Participants drain their accounts prematurely; for example, taking loans and other withdrawals when employed or taking a distribution when changing jobs, rather than rolling the account over to a new employer’s DC plan or an individual IRA.
This article will focus on certain initiatives that plan sponsors of DC plans can undertake to help address the first item: increasing participation. We will address the other issues in future articles.
What Can Plan Sponsors Do?
A study from the Defined Contribution Institutional Investment Association‘s (DCIIA) “Plan Sponsor Survey 2012: Action Needed to Drive Better Participant Outcomes” found 45% of the plan sponsors identified “increasing participant savings rates” as either their first or second priority, and 25% identified “increasing participation rates” as either their first or second priority. These survey results indicate that plan sponsors are not only cognizant of these issues, but have identified them as higher priority goals. To help achieve these goals, many plan sponsors are employing programs to educate participants on the importance of retirement saving and investing. Additionally, the adoption of certain plan features can be instrumental in encouraging increased savings and participation. These common features include:
- Automatic contribution escalation
- Matching contributions
We’ll start with automatic enrollment in this newsletter and discuss escalation and matching in future issues.
The utilization of automatic enrollment features is on the rise:
According to the DCIIA’s 2012 survey, 56% of plan sponsors surveyed used this feature, up from 44% in 2010. Although employees may always opt out, implementation of automatic enrollment increased average participation rates from 69% to 81%; signifying that automatic enrollment increases participation.
There are various options for applying automatic enrollment features. A large majority of plans only apply automatic enrollment to new hires. Some plans take it a step further when first implementing automatic enrollment by applying automatic enrollment to all existing employees who are not participating in the plan upon initial implementation. More aggressive plans have an annual or other periodic enrollment window where all current non-participating employees will be automatically enrolled.
Although automatic enrollment increases plan participation rates, there is a concern that it might not be enough to increase saving rates. For example, a new employee may simply elect to be automatically enrolled in a plan rather than enrolling himself or herself. If the default contribution rate is lower than a rate the employee would have selected on his or her own, then the actual savings rate would be lower. Default contribution rates tend to be low with 54% of plans using a default contribution rate of 3% or less, according to the DCIIA 2012 survey. Since experts cite 10% as the minimum amount of annual compensation that should be saved for retirement, this 7% gap is a concern. While automatic enrollment can help achieve the goal of increasing participation, it may not be helpful in increasing savings rates.
As a plan sponsor, evaluate the default contribution rate carefully before considering implementing an automatic enrollment feature. If your plan has existing automatic enrollment features, revisit the default rates with the goal of setting the plan at the optimal default contribution rate (i.e. the highest rate deemed possible that will not risk unacceptable opt out rates). To mitigate the potential loss of participants due to a higher default rate, an aggressive approach to enrolling employees at a rate lower than the default rate should be pursued. Once an employee is automatically enrolled in the plan with an optimal default contribution rate, overall savings rates can be improved through automatic escalation features and matching contributions. Look forward to our next article for more advice about this.
Automatic enrollment features have proven to be an effective means of increasing plan participation. In addition to helping to improve participant outcomes, the increased participation can help plans comply with the non-discrimination requirements. Sponsors of plans without automatic enrollment should give it careful consideration.
Our next article will discuss ways to improve savings rates. Click here to view more resources on this subject.