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Making Retirement Saving Easier for Employees

What stops us from saving for retirement? It isn’t our lack of awareness of the need, but our inability to go into action. One problem is that we see the risk of retiring without enough money as a distant possibility, rather than an inevitable reality that will arrive sooner than we think.

The truth is less than 5% of Americans have enough net worth to be financially independent in retirement. Sixty-eight percent self-assess they aren’t saving enough for retirement.

Employers can help change these dismal numbers by influencing the way their employees make investment decisions. The most popular retirement savings plan is the 401k plan. Most employers require their employees to make a decision to opt-in to the plan. Opting-in actually plays into the “inability to go into action” of most employees, as only 37% of employees actually sign on to the plan.

The inability to go into action isn’t helped by more education. In a study on Pension Design and Structure, Mitchel and Utkus found that immediately after a seminar for employees on the benefits of opting in to their 401k plan, 100% said they were going to join the plan. Over the next six months only 14% actually carried through on their commitment. Of employees enrolled in the plan, 28% said they were going to increase their contribution to the plan, but only 8% actually did.

To help employees go into action, a growing number of employers are beginning to automatically enroll new employees in the 401k plan. This requires them to opt-out if they don’t want to participate. Amazingly, this increased plan participation rates from 37% to 86%.

Making investment decisions is equally difficult for most 401k plan participants. Mitchel and Utkus discussed several studies focusing on this issue.

When employees were given a choice between holding their own portfolio or the portfolio of the average participant in the plan, about 80% chose the average portfolio. That’s like going into the operating room with a ruptured appendix and telling the surgeon, “Just give me the same operation your last patient had.”

In another study, participants were asked to allocate their 401k contributions between two investment funds. The first group was given a choice of a bond fund and a stock fund. A second group was given the choice of a bond fund and a balanced fund (50% in stocks and 50% in bonds). A third group was given the choice of a stock fund and a balanced fund.

In all three cases a common strategy was for participants to split their contributions equally between the two funds offered. Yet because of the difference in the funds, the asset allocations of each group differed radically. The first group had an average allocation to stocks of 54%, the second group 35%, and the third group 73%.

In another experiment, participants were asked to select investments from three different menus offering options with varying degrees of risk. Most made their choices simply by avoiding both the high-risk and the low-risk extremes. They didn’t select a portfolio from the available options based on the appropriateness of the risk each presented.

These studies suggest ways employers can help employees make better investment decisions. One strategy would be to reduce their investment choices to a small number of funds that offer portfolios with an asset allocation based on various target retirement dates.

By making participation instead of non-participation the default choice, and by offering investment choices pre-selected for appropriate asset allocation, employers can make a huge difference. These strategies don’t merely encourage employees to participate in 401k plans, but actively help them take full advantage of those plans.

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2 Responses to Making Retirement Saving Easier for Employees

  1. Roger Wohlner March 7, 2011 at 6:23 am #

    Rick great post as usual. I agree with everything said. I’d take it one step further and submit that plan participants need access to direct one-on-one investment and retirement advice. Education is great but doesn’t seem to work. Many plans offer online tools and these are fine for some employees. The advice, however, needs to be unconflicted, no product sales, no rollover pressure. Further the advice provider should act as a Fiduciary for the advice provided. Hopefully the advice provisions of the Pension Protection Act will be finalized at some point in the near future.

  2. Susan Weiner March 7, 2011 at 7:51 am #

    Auto-enrollment seems like a no-brainer to me. I wish more companies followed your advice.