How to Make Lemonade from your 401k Plan's Lemons

Last Updated Jun 27, 2010 6:30 PM EDT

While the rise of the 401(k) has ushered in the age of personal retirement responsibility, your employer still has a huge hand in whether you reach your retirement planning goals. Afterall, it's your employer who makes all the decisions on how to structure your 401(k) plan. And new data from the Transamerica Center for Retirement Studies suggests many employers are serving up 401(k) lemons in the choices they make for their 401(k) plans. That just creates another retirement planning step: make sure you know where the lemons are in your 401(k) plan and turn them into lemonade.

401(k) dysfunction
It's not as if employers aren't aware of the importance of offering a robust retirement plan. Over the past five years, there's been an increasing shift toward understanding salary alone isn't enough to attract and retain talent.

Source: Transamerica Center for Retirement Studies

And employers reported in the Transamerica survey that they are doing a bang-up job delivering a solid 401(k) plan:
  • 97 percent of employers say they give their employees the right information to make sound decisions about their plan.
  • 95 percent of employers say they are satisfied with the plan provider.
  • Employers say 98 percent of employees are satisfied with the plan.
So everything is great in 401(k) land, right? Not so fast:
  • Barely half (53 percent) of employers say they are very confident or somewhat confident their employees will achieve a comfortable retirement. (Among larger firms nearly two-thirds are optimistic about their employees' retirement security.)
  • Three quarters of employers say their employees prefer not to think about retirement issues until they are closer to their retirement date.
A quick recap: Employers think their plan is just fine, it's the employees who are screwing up.

To be sure, there is plenty that individuals get wrong. But the Transamerica survey makes it quite clear that employers are to blame as well.

  • Less than one in four plans offer auto enrollment. And 84 percent of firms surveyed said they have no immediate plans to add auto enrollment.
  • Among the plans that do offer auto enrollment, the median contribution rate is just 3 percent; a data point that has not budged over the past three years. Even if we assume a generous company matching 401(k) contribution, employees are still saving at about half the rate that is needed.
  • More firms are using cash as the default contribution. In 2008/2009 53 percent of employers were using a target date retirement fund. Today it's down to 40 percent. Meanwhile, the percentage of employers using a money market or guaranteed investment contract (GIC fund) as the default has shot up from 12 percent to 33 percent in the same time frame. (The conservative march is mostly a small-firm issue. Nearly two-thirds of large companies use a target retirement fund, up from 46 percent two years ago.)
The most glaring mistake plans continue to make is the refusal to adopt automatic escalation of 401(k) contribution rates as a standard feature. The percentage of firms offering auto escalation has actually declined since 2008/09 from 29 percent to 24 percent. In other surveys, plan sponsors have said they don't want to run the risk of annoying employees by adding auto enrollment and auto escalation to a 401(k) plan. Yet the evidence suggests employees probably wouldn't make a peep about it today, and would be incredibly grateful years from now when they realize it helped them save more for retirement.

The TransAmerica survey reports that 90 percent of folks who have been auto enrolled into a plan were fine with it. That's a resounding approval rating. And anecdotal evidence suggests employees would be just fine with any save-more nudges

Pamela Hess, director of retirement research at Hewitt, recently mentioned that one plan sponsor increased the default contribution rate to 6 percent of salary (double the industry median), and another set a default at a maximum of 8 percent. In both instances, employees didn't storm HR. "There is typically a fear of how participants might react," says Hess. "But most sponsors hear very little noise."

That's in sync with what Bob Veres recently reported in his column for Financial Planning magazine. Veres laid out recent research from Harvard economics professor David Laibson on how employees enrolled in a 401(k) plan react to various default contribution rates:

When the default contribution was 2% of the worker's salary, almost 100% of the workers made 2% contributions-even though the plan allowed up to 15%, with employer matches rising accordingly. When the default contribution went up, those higher contribution rates became the norm-until about 15% of salary, at which point workers began to realize that their paychecks were painfully diminished. But even then they didn't opt out altogether; the majority dialed down their contribution rate instead.
Your 401(k) Lemonade Recipe
Waiting for your employer to wake up and realize it could be doing a hell of a lot better job setting you up for 401(k) success could be a long wait. In the meantime, here's how you can turn the lemon default choices in your 401(k) plan into lemonade:
  • If you aren't already maxing out on your 401(k) contribution, increase your contribution rate by at least one percentage point every year until your total contributions (yours and your company match) are at least 15 percent of your salary.
  • Do not hide out in the money market or GIC fund. Yes, some cash is good. But if you've been auto enrolled into a 401(k) plan and 100 percent of your money is in a stable value fund, that's a big mistake. (Easy solution: target date fund.)
  • Don't assume your employer knows best. The default settings used by many employers are not ideal for helping you reach your long-term retirement goals. Challenge every default setting in your 401(k); more often than not you can do a lot better taking control of your future than relying on what your employer thinks is best.
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