Advisers’ big opportunity in the small 401(k) plan space

Education in the small plan 401(k) market for both plan sponsors and plan participants is vital to the success of a plan. Plan sponsors need education to make sure they understand their fiduciary responsibilities, are offering the proper mix of investment options, have implemented an appropriate plan design with the right mix of plan features, and are maximizing the benefit they provide their employees.
An education policy is imperative to ensuring there is formal employee communication and an education strategy in place to inform participants about their benefit on an ongoing basis. Effectively executing on the education policy is fundamental to helping employees reach their retirement goals.
Unlike larger companies that typically have sufficient internal resources to properly facilitate a 401(k) plan, smaller companies lack the resources, time and staff to address what’s required of them to properly institute a qualified plan. They desperately need the help and education advisers can provide to increase understanding of plans in general, build an education policy and appropriately educate employees.
According to the Guardian Small Plan 401(k) RetireWell Study, there were five areas where small business owners perceived disadvantages with 401(k) plans, including cost, fiduciary risk (almost one third of small business owners didn’t realize they were the plan fiduciary), the complexity of retirement plans and providing education to employees. These are all areas where advisers can provide considerable assistance, support and education.
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START THE CONVERSATION
Whether addressing concerns on cost through fee benchmarking, or explaining the role of a plan fiduciary and its responsibilities, educational activities can go a long way toward improving overall plan health.
Basic questions about the current plan can help reveal opportunities: 1) Do they know they are a plan fiduciary and do they understand what that means? 2) Do they have an education policy? 3) Do they have a diverse set of investment options that are regularly monitored? 4) What are the participation rates? 5) Does the current plan design maximize tax benefits for the owner and employees?
THE IMPORTANCE OF AN EDUCATION POLICY
The Guardian survey revealed there’s a general lack of understanding of some basic investment terms among participants. Only 50% of those surveyed had heard of target date funds; 45% were aware of dollar cost averaging and only 39% were familiar with target risk funds.
While familiarity is one thing, comprehension is another. Two-thirds of participants who had heard of target date or target risk funds asserted they did not understand the term. Seventy-seven percent had heard of vesting but fewer than half said they understood the term completely.
Plan participants need a better grasp of basic retirement planning terms to understand how their 401(k) plans work and how they can be used to meet their financial goals and maximize their contributions. Lack of comprehension leads to a lack of engagement. In fact, almost 40% of all small participants did nothing with their 401(k) last year. While sometimes this may be a good thing, it also indicates they did not increase their contribution (only 16% of participants did) and did not rebalance.
(More: Lessons for advisers from Supreme Court’s decision on 401(k) excessive fees lawsuit)
GAP CALCULATIONS HELP INCREASE CONTRIBUTION RATES
The Guardian study suggests the vast majority of plan participants are not contributing as much as possible to their plans. Only 15% of those under age 50 are maxing out their contributions, while only 11% of respondents over age 50 were contributing as much as allowed. Plan participants are also preoccupied with fund accumulation rather than on how the money they’ve accumulated will translate to actual retirement income. Fifty-four percent focused on looking at their 401(k) balance but only 29% paid attention to the income their account can generate in retirement. Participants are stuck in an accumulation mindset.
Advisers can use the power of a gap calculation to encourage clients to increase their contribution rates. When presented with information showing that their current contribution rate would only enable them to replace 50% of working income in retirement, 41% of those surveyed indicated they were likely to increase their contribution rates. 25% of participants said they would increase their contribution rates if it meant achieving a 100% income replacement ratio.
Participants also said they were more likely to increase their contribution rates if they had a better understanding of available investments in their plan, had a financial professional show them how to invest assets, had better education materials from the company servicing their 401(k) plan, or if they learned that others of the same age and income were saving a bigger proportion of their income than they were.
KNOWLEDGE CLOSES THE LOOP
There is ample opportunity for advisers to address large voids in the small plan market and to help increase savings for employees. An emphasis on education, which links comprehension, clarity and participant engagement, goes a long way.
The more sponsors know, the more they can do to maximize the benefit they offer their employees, and the more participants know, the more they will save.
Douglas Dubitsky is vice president at Guardian Retirement Solutions.