There’s also been a lot of research suggesting that many plans have already adopted this approach, but don’t believe it—like most conventional wisdom, it’s less than accurate.
In fact, most small and mid-size DC plans are just beginning to jump on the behavioral finance bandwagon associated with the “ideal” concept, with just a few adopting its auto-plan features.
Essential Elements
What exactly is the “ideal” 401(k) plan and how can it affect retirement security?
As part of a Plan Sponsor University (TPSU) research effort in 2013 – 15, more than 500 DC plan sponsors were asked in training sessions to outline what they would consider their ideal plan. Key results included the following:
- Auto-enrollment at 6% deferral
- Auto-escalation of 1% annually, ideally in conjunction with a raise capped at 12%
- Stretch match to the escalation cap (25% of 12% v. 50% of 6%, for example)
- Default option using a target date fund or managed account
Based on resulting simulations following this approach, the results over a participant’s lifetime were said to potentially triple or even quadruple account balances compared to a plan with just 3% deferral and no match. You can quibble over the specifics, but few would argue that the results of an “ideal” plan have the potential to be significantly better than those of a “regular” plan.
Driving Participation
Mechanically, what makes the above combination of factors work?
By leveraging inertia, auto-enrollment is key to increasing participation. Setting the right deferral rate is also important, with little difference in participant dropout rate at 6% compared to 3%. Auto-escalation at the time of a raise leverages inertia and resistance to loss. People tend to defer to the match, so stretching it increases deferral rates, as does auto-escalation. Also, most people do not have the expertise or desire to create portfolios or rebalance them, making professionally managed investments like target date funds and managed accounts attractive as the default option.
Small and Large Plan Differences
Now let’s look at data comparing the Callan 2018 Defined Contribution Trends survey with the Society for Human Resources Management’s (SHRM) 2018 Employee Benefits survey. While Callan does not list the demographics of its study, Callan’s clients include mostly institutional plans with more than $1 billion in DC assets. In contrast, almost 70% of SHRM’s respondents are plan sponsors from companies with fewer than 500 employees.
The difference in implementation is startling (see table below). Just 40% of SHRM plan sponsors used auto-enrollment in 2017, a figure that dropped to 38% in 2018 and has not increased since 2014. Although the use of auto-enrollment has been flat among Callan respondents, 71% used it in 2017. Even more telling, 70% of Callan plan sponsors used auto-escalation in 2017, up from 48% in 2014, while just 19% of SHRM plan sponsors used it, dropping to 18% in 2018.
Finally, while most of SHRM’s respondents offered a match, just 46% have a target date fund. In summary, while some plan sponsors captured within SHRM’s study use some part of the “ideal” plan framework, very few implement the entire program.
Because Callan’s survey and studies from other institutional plans are publicized broadly through industry press coverage, it may seem that most plans incorporate components of the “ideal” plan. However, these results are skewed toward larger plans. The results from the SHRM study show that many smaller plans have yet to ramp up “ideal” plan components, presenting the retirement plan advisors who work with them an opportunity to differentiate themselves from other advisors by suggesting these components, and, in turn, potentially helping clients improve retirement security.
Ready for Advice: Many Plans Have Yet to Ramp Up ‘Ideal’ Plan Components
| 2014 | 2015 | 2016 | 2017 | 2018* | ||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Callan | SHRM | Callan | SHRM | Callan | SHRM | Callan | SHRM | SHRM | ||
| Auto Enrollment | 71% | 40% | 66% | 38% | 70% | 38% | 71% | 40% | 38% | |
| Auto Escalation | 48% | 19% | 51% | 18% | 72% | 19% | 70% | 19% | 18% | |
| Default Rate | 4 | 4.2 | 4.6 | 4.6 | ||||||
| Cap of Deferral | 19 | 27 | 33 | 33 | ||||||
| Has Match | 74% | 73% | 74% | 76% | 74% | |||||
| Has TDF | 46% | 44% | 45% | 46% | ||||||
Source: Callan 2018 Defined Contribution Trends survey and SHRM’s 2018 Employee Benefits survey.
