by Brad Knowles, Heritage Institutional
There are myriad reasons why an employer maintains a qualified retirement plan. They may use it as a talent attraction and retention tool. They may see it as a necessity to keep pace with industry peers. But perhaps the most important reason is to provide a means through which their employees may save for the future. The plan should mean security and dream fulfillment for a loyal workforce.
Over the years traditional pension plans have faded and been replaced by defined contribution (primarily 401(k)) plans. But these defined contribution plans were never meant to carry the full load of retirement savings. They were meant to supplement the much more robust and well-designed (for impactful retirement savings) traditional pension plan. A pension plan places all of the decisions, and responsibility, in the hands of the employers, who tend to possess a greater degree of sophistication than do many employees. In contrast, most supplemental defined contribution plans shift those decisions to employees. Unfortunately, studies haveshown that many, if not most, of these employees are ill-equipped to make good decisions in planning for their futures.
So what’s the answer? Employers have to become more courageous. They have to start by answering the question, “what is the purpose of our plan?” If the answer is “to create the most efficient retirement savings tool possible for my employees,” they have to accept the fact that they need to take a step back in time. They need to make their 401(k) plans operate more like the traditional pension plans of old. They need to become more paternalistic. They need to go back to making good decisions on behalf of their employees. Some of these decisions may take the form of plan design. Some may take the form of diverting more corporate focus and attention to their plan. And some may require contemplating the best use of corporate dollars.
Courageous plan design includes redesigning plans to eliminate potential points of leakage like in-service withdrawals, hardship withdrawals and even loans. It includes taking advantage of behavioral finance to include automatic enrollment and automatic escalation features to ensure employees get into a plan then defer appropriately. It includes conducting prudent due diligence in regards to investments and fees. It includes the employer considering bearing the administrative costs of the plan instead of passing them onto their employees.
Some of these may seem like drastic changes, and some may seem miniscule in impact. The truth is every single incremental change may have a large impact on an employee’s ability to reach his/her retirement goals. At the end of the day, even the wisest employees don’t make the best decisions. However, it is within the employer’s power to help them avoid mistakes, if the employer has courage.
Behavioral Finance and Plan Design
401(k) plans have been around for more than 30 years now, and we have learned much about what has worked and what has not. As pension strategies have migrated from the traditional defined benefit (DB) plans to the ubiquitous defined contribution(DC) plans, two key events occurred. Plan sponsors removed themselves from the enormous funding implications and investment responsibilities inherent in DB plans and transferred these responsibilities to the participants. Unfortunately participants have not picked up these responsibilities.
As a plan sponsor, if you subscribe to the view that success of a 401(k) plan is really measured by your employees’ ability to replace their income at retirement, then this effectively becomes the definition of a successful plan. If we agree, then we have work to do. Currently, our industry spends nearly $1 billion annually on employee investment education and support, and we have yet to move the needle in terms of achieving viable retirement outcomes. We now know employee education alone is not the answer. Participants are making all the same retirement investment mistakes as they made 30 years ago.
The science of behavioral finance has been very helpful in illuminating why most participants do not engage with their plan. Studies have shown participants have no interest in learning how to fly the jet; they want the pilot to do this. The job of pilot then falls to the plan sponsor.
Issues of lethargy, intimidation, procrastination, loss aversion, hyperbolic discounting (retirement would be great, but I really want that new gadget now) are debilitating to participants, but can be overcome by the influence of a concerned plan sponsor. We have all the tools to help effect positive change.
A Great Time to be Courageous
Over the past several years, we have worked with our clients to move the needle when it comes to Courageous Plan Design. Each year, we calculate how many positive plan metrics our plan sponsor clients have been able to implement. In 2014, that number climbed to its highest yet. Now there is a big push to show how the behavioral finance behind Courageous Plan Design can help achieve those positive plan outcomes we all seek.
Brad Knowles is the Managing Director of Heritage Institutional and is one of fewer than fifty advisors nationally to earn the Certified Behavioral Finance Analyst (CBFA) designation. You can read more about Brad here.