Time for a new 401(k) model?

Automatic features of the 401(k) have improved savings opportunities for millions can workers over the past few years, but more could be done now and no new legislation is needed.

Mark Iwry, senior advisor to the Secretary of the Treasury for retirement policy, acknowledges that automatic 401(k) features have gone a long way to improve retirement saving opportunities for American workers. He dubbed the widespread use of automatic enrollment of new employees and default investment options such as target-date or balanced funds or managed accounts “401(k) 2.0”. But why stop there? “We could move to a 3.0 model that’s more robust — without additional legislation and without a material increase in cost to employers,” he said during a panel discussion of proposed retirement plan innovations sponsored by the U.S. Chamber of Commerce Commerce in Washington this week.

Rather than settling for the standard 3% default rate for the initial salary deferral of new employees who are automatically enrolled in their company 401(k) plan, Iwry suggested starting at a higher level, perhaps 5 or 6%. And instead of limiting auto enrollment to new employees, why not expand it to existing employees who are not participating in the retirement plan? He also recommended lifting the cap that some plan sponsors place on automatic escalation arrangements that are designed to boost employees’ 401(k) contributions by 1% or 2% for each year. Instead of setting an arbitrary contribution cap of 6% or 10% of salary, Iwry suggested that the annual maximum contribution limit–currently $17,000 ($22,500 for those age 50 or older) — – be the only restriction 401(k) plans impose on employee salary deferrals.

Iwry also suggested that a “401(k) 3.0” could have a variety of other “best practices” to encourage saving. These might include more effective employer matching contributions (including matching formulas that encourage higher employee contributions, even if at a lower cents-on-the-dollar rate, or that offer lower-wage workers a higher rate of match). In addition, he would like to see shorter eligibility waiting periods; broader coverage of part-time workers; expanded acceptance of rollover contributions; and corporate cultures that encourage employees to contribute at least 10% of pay. Employers should help employees understand how much retirement income their current account balance would create and offer retirement income payout options from 401(k) plans.

“These are things we can move on right now. We don’t have to wait,” he said.

One of the biggest challenges to future retirement security is to increase the number of Americans who have access to a retirement plan at work. Tens of millions of workers don’t, particularly those employed by small businesses. The Obama administration has proposed to make workplace saving accessible to those workers by providing a tax credit for small businesses with more than 10 workers that don’t sponsor a plan. Those businesses would be required to automatically enroll employees in salary- reduction contributions to an IRA. Employees could opt out and employers would make no contributions of their own. “To the extent that there would be any administrative cost to employers, the tax credit would defray that cost,” Iwry said. And given that the tax credit would offset any costs, Iwry said, “It would not be fair to call this a ‘mandate’.”