Pushing employees to save more for retirement is a noble cause for financial advisers, but getting employers to go along is easier said than done.
Employers that automatically enroll workers in 401(k) plans often start them off at a default deferral rate of 3% of their compensation, per the starting rate in the Pension Protection Act of 2006. However, the Employee Benefits Research Institute released data last month showing that a 6% deferral rate vastly improves retirement outcomes for employees if they automatically begin socking away more money while they are young.
The positive effects were felt among workers of all income levels, but those who made the least amount of money benefited most. By using a 6% contribution levels, 71.8% of the workers in the lowest-income quartile were projected to be able to replace 80% of their income, accounting for Social Security.
By comparison, at a 3% deferral rate, just 62.1% of these workers were projected to reach that same level of success, according to EBRI — and that is assuming that these employees were automatically raising their deferral amount annually by 1% of their pay, that they started saving again at the default rate of 3% when they changed jobs and that the plan put a 15% cap on employee contributions.
A number of obstacles, particularly the burden of increased administrative costs, keep smaller employers from raising those deferral rates, advisers note.
The biggest difficulty is getting them to adopt automatic enrollment for the retirement plan in the first place. Then they fret because having more participants in the plan could lead to more fees stemming from more accounts to administer, said George Fraser, a managing director at Retirement Benefits Group LLC, an affiliate of LPL Financial LLC.
“For the smaller employer, it's a nice idea, but just something else on the list of an overworked payroll person who is also handling human resources,” said Keith Olshove, a vice president and retirement plan officer at Northwestern Bank of Traverse City, Mich., whose typical plan sponsor has fewer than 100 employees.
Finally, to the extent that a company matches a worker's retirement plan contribution, when people sock away money at higher rates, it raises costs for plan sponsors.
“For smaller employers, where things can be [financially] tight at times, the matching contribution can be an issue,” said Marcy Supovitz, principal at Boulay Donnelly & Supovitz Consulting Group Inc.
Obstacles aside, advisers point to factors that can motivate plan sponsors to adopt auto-enrollment and kick up default deferral rates.
For instance, the Internal Revenue Service puts a limit on 401(k) deferrals by highest-compensated workers so that the average deferral percentage of the group is no more than 2 points higher than lower-compensated workers. The rule, referred to as “nondiscrimination testing,” is intended to ensure that lower-paid workers — and not just the highest-compensated employees — are able to save more for retirement.
“If you have poor participation among the non-highly compensated people, those are zeroes into that formula, and it brings down the average deferral rate, limiting what highly paid workers can put in,” Ms. Supovitz said. “Nondiscrimination testing is one strong motivation for raising automatic deferrals.”
Bosses also can influence workers to put part of every raise into their retirement plans.
“You get a 2% raise and then put 1% more into the plan and the other 1% into your checking account,” Mr. Olshove said. “We encourage people to raise their contribution rates with that [example].”
In some cases, getting employers to adopt higher default contribution rates requires advisers to ease them into the process and start small.
“Small employers know the personal issues within the company,” Mr. Fraser said.
“You might be in the HR department, and your friend at the office who is a low-wage earner might not be able to afford new tires for their car. [But the automatic deferral would] take 6% out of their pay,” Mr. Fraser said.
To get employers over the difficulty of pulling a larger chunk out of low-wage earners' pay, he proposes starting the lowest earners at a very low deferral rate and then raising it to 6% within five years.
“It's a game changer,” Mr. Fraser said. “The benefits person who was vehemently opposed to it realizes that it works if you start lower earners at a lower number.”
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