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The New 401(k)

A rise in corporate 401(k) balances and contributions reveals that the new design of retirement plans is working. Financial experts think companies can do even better in helping their workers to realize retirement readiness.

Monday, December 17, 2012
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Despite today's harsh economic landscape, national investment companies are seeing an encouraging rise in corporate 401(k) balances and contributions. According to one of the country's largest 401(k) providers, Boston-based Fidelity Investments, the average 401(k) balance reached $75,900 at the end of the third quarter, which marks an all-time high since the company began tracking the data more than 12 years ago.

"It's always good news when retirement balances go up," says Jeanne Thompson, vice president of market insights for Fidelity Investments in Boston. "But that figure of $75,900 is an average of 12 million 401(k) accounts in more than 20,200 corporate defined contribution plans, so it's not taking into account that some of these people are young and starting out and may have a low balance; and some of them are older people who may have a large balance. You get more insight by looking at people who have been in the plan for ten years. For these folks, the average balance is $198,800. For many people, the 401k combined with Social Security or IRAs or retirement plans will make up the income they'll have when they enter retirement."

Thompson attributes this rise in 401(k) balances to two factors: the stock market rebound and increasing contributions. "Over the past year, much of the growth was due to the market, but over the long haul, historically, the market has gone up," notes Thompson. "However, employer and employee contributions have also gone up, and this is by design."

The Fidelity report found that in the past five years, annual contributions made by employees grew 7.3 percent, while average annual employer contributions rose 19 percent. Thompson says that features designed to increase savings and participation, including auto-enrollment and auto-escalation, have been a driving force behind the good news, but there are ways in which employers can help their workers achieve even stronger outcomes.

"Getting younger employees into your company's plan through automatic enrollment starts them on the right path and guides them in the right way," says Thompson. "And auto-escalation – where an employer can automatically increase their contributions every year – has also proven to be very effective at influencing behavior."

"There's been a lot of innovation and change in the design of 401(k) plans," acknowledges Sarah Holden, senior director of retirement and investor research for the Washington, DC-based Investment Company Institute (ICI), which is the national association of U.S. investment companies. "A worker today is looking at a very different 401(k) than someone who started a decade ago."

According to Holden, auto-enrollment is a first step that often leads to participants taking advantage of their provider's offer to make asset allocation decisions for them. "Some people enjoy investing, while others don't want to make those decisions," she says, noting that increasingly diversified investment options that automatically rebalance over time are being offered.

A target date fund – which reallocates investments over time to line up with a participant's expected date of retirement – is a recent trend for new hires, says Holden. "Seventy percent of 401(k) plans in 2010 offer target date funds. In 2006, it was only 57 percent," she notes, quoting data from a collaborative research effort with the Employee Benefit Research Institute (EBRI). "These funds are diversified, incorporating a mix of stocks, bonds and cash. They also rebalance over time, so if the participant is younger, today's fund will have a high concentration in equity. As they age, the asset allocation will automatically rebalance so it's less focused on growth and more focused on income.

 "Target date funds provide a broader range of options for those who want to pick individual funds. If they want, employees can hand those decisions off; in addition, some opt to let the employer choose their contribution rate, often allowing it to increase over time. Today's plans are catering to a range of involvement to get workers on the path to saving in a diversified way. Part of the beauty of the automatic enrollment design is the fact that it works within a person's life cycle."

Holden points out that employers who design retirement plans to cater to their workforce are getting it right. "The employer is signaling to their workers that saving for retirement is important, and this is a benefit," she says. "They're trying to attract qualified workers with these plans, and from the results of our household surveys, a feature people appreciate in 401(k) is that it helps them think about the long term. They also appreciate the ease of payroll deduction and the tax deferral."

Jean Young, senior analyst with the Vanguard Center for Retirement Research, located in Philadelphia, points to investor behavior as another reason 401(k) balances and contributions have risen. "Most participants are balanced investors, and they stayed the course and continued making their contributions despite market lows. They didn't panic," says Young, adding that balanced portfolios provide stability.

"The whole trick with plan design and automatic enrollment and automatic increases is putting employees on the right path," says Young."Through the design, you affect strong savings behaviors. You're helping your workers to do the right thing for themselves, and you've made it easy."

Default decisions in auto-enrollment for auto-increases should be raised so that workers are eventually seeing combined contributions of 12 to 15 percent going toward their retirement.

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Writer and publisher Steve Vernon, FSA, is the president of Rest-of-Life Communications from Oxnard, California. "We want to applaud and celebrate balances rising, but for the most part, people are woefully underfunded for their retirement, and they need to be contributing more. We can't rest on our laurels and think the problem has been solved."

 It's important to hit people in the heart to get them to commit to a savings plan. "A communications campaign must appeal to people's emotions," says Vernon, adding that showing people that their peers are also saving puts out a message that everyone is doing it.

Auto-escalate can be improved by offering an increased percentage of matching contributions. "Auto-escalate used to stop at 6 percent contributions," Vernon recalls, "but you have to save about 15 percent of your pay over a long period of time, so you want the auto-escalate to increase, and the higher the better."

Vernon says that the best thing companies can do is continue to promote the message that saving is important. "It has to be something you're always doing, because repetitions make the message sink it. It's a long-term campaign," he says.

"A lot of big companies are now promoting wellness programs, which are proving successful with employees. A new twist on that is to promote financial wellness and tie that message to the success of physical wellness," Vernon says. "It sends a powerful messages that your later years will be better when you arrive healthy and with money."

Marina Edwards, a senior retirement consultant at Towers Watson's Chicago office, says that technology also plays a part in helping workers to determine retirement readiness. "There are now online calculators and tools that will take a participant's current rate of contributions and project out to the age they will retire to determine whether they're on the right track. If not, these tools can give them ideas of what they can do differently.

"There is oftentimes a cost to it, but similar to how a record keeper sends out statements, employers can send out a total compensation statement on an individual basis to reflect the total benefits the company is providing to the employee," says Edwards, noting that the big consulting firms commonly do this for their clients.

Edwards says that HR leaders must focus on their workers' retirement readiness. "If not, you will have a workforce that is not prepared for retirement, and they won't retire. Then you have a higher cost in paying a larger salary to those older workers and more workmen's comp cases, because they're aged. Workers who can't retire also have a lower morale. That's why it's imperative that employers help their employees get out the door at age 65."

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