How Plan Design May Impact Participant Behavior
Retirement plans that harness the power of human behavior by working for retirement savers instead of against them can help maximize participants' retirement outcomes.
Implementing automatic plan design features can help you elevate your retirement plan and make a significant impact on your employees' participation and savings rates.
Automatic features encourage savings behavior
Based on analysis conducted by the Principal Financial Group®, employees may need to save at least 10% their pay, plus employer contributions, throughout their career to have enough income in retirement. This assumes they may need about 85% of their pre-retirement income to maintain their current lifestyle after they retire. Each individual's situation is unique, though, so savings and post-retirement needs may differ.
Increasing the automatic enrollment default to 6% or more can have a positive impact on participant savings rates overall and there is little difference in opt-out rates.
As illustrated above, plans that have a 6% default deferral rate, 41% of participants reach an overall savings rate of 11% or more and opt-outs from the plan increased by just 7 percentage points (17%) compared to those in plans with a 3% default rate (32% reached an overall savings rate of 11% and 10% opted-out of the plan).
Impact inertia with automatic escalation
When given the chance to proactively opt-in to automatic escalation, very few do. Similarly, when given a choice to opt-out, very few do.
As a result, adding automatic escalation with 1% annual increase can work for the retirement saver.
The power of the match
Stretching the match can encourage savings behavior
Manage your costs while motivating your employees to save more and get on track toward a successful retirement. "Stretching" can be an incentive for your employees to save more without costing you more in matching contributions.
In the two different employer match formulas illustrated above, the employer contribution is the same. You can see as the match "stretches," the participant contribution tends to increase without increasing the overall matching contribution amount.
Retirement ready plan designs
In addition to automatic enrollment with at least 6% elective deferral, automatic escalation of at least 1% per year up to 10% and stretching the match, The Principal® suggests:
- Automatically sweeping all eligible employees deferring less than the automatic enrollment default into the plan at least one time. Sweeping all eligible employees can immediately improve participation in your retirement plan and may improve passage of annual non-discrimination testing.
- Naming a diversified investment option(s) as the qualified default investment alternative (QDIA). The use of a QDIA can help protect plan fiduciaries from liability. Changes made by the Pension Protection Act provide protection to plan fiduciaries as long as defaulted contributions are invested according to QDIA regulations.
Consider making plan design changes to help maximize your participants' retirement outcomes. Contact your financial professional or representative from The Principal for more information.
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- Retirement Savings Research
- Based on analysis conducted by the Principal Financial Group®, August 2013. The estimate assumes a 40-year span of accumulating savings and the following facts: retirement at age 65; a combined individual and plan sponsor contribution of 12%; Social Security providing 40% replacement of income; 7% annual rate of return; 2.5% annual inflation; and 3.5% annual wage growth over 40 years in the workforce. This estimate is based on a goal of replacing about 85% of salary. The assumed rate of return for the analysis is hypothetical and does not guarantee any future returns nor represent the return of any particular investment. Contributions do not take into account the impact of taxes on pre-tax distributions. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs.
- Assuming pre-retirement annual gross income of $40,000. Aon Consulting's 2008 Replacement Ratio StudyTM www.aon.com/about-aon/intellectual-capital/attachments/human-capital-consulting/RRStudy070308.pdf
- The Principal. Data based on 1,973 salary deferral service plans with automatic enrollment defaults of 3% and 6% as of December 31, 2013.
- The Principal. Data based on a combination of 66,798 participants opting out of automatic increase and 72,030 opting in to the Principal Step Ahead Retirement OptionSM in salary deferral service plans as of 12/31/13.
- The Principal Financial Group®. Analysis based on 172 contracts that showed a stated match formula. Total contribution percentage includes participant contribution and employer match (as of 12/31/2013).
The selection of any investment options on behalf of a plan is the fiduciary responsibility of the appropriate plan fiduciary, which is not Principal Life, nor any affiliate. Plan fiduciaries remain subject to a varying amount of ongoing responsibility, depending on the structure of the plan the fiduciary serves and the nature of the plan fiduciary's position. Please consult with your counsel or other advisor as to the responsibility of a plan fiduciary with regard to the selection or retention of any plan investment option by a plan fiduciary.
Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group (The Principal), Des Moines, IA 50392.