3 Ways To Change Communities Through 401(k) Plans

As more baby boomers near or enter retirement age, there’s a realization that many Americans regardless of their generation have little to no retirement savings. In large part this is because pensions have become less popular over the past few decades.

It’s rare to have a pension plan these days, and those without pensions may not have access to a retirement plan through their work either. Not only does this present an issue for middle- and upper-income individuals, but it’s also a real problem for lower-income individuals, especially those in underserved communities.

Financial planners have an opportunity to change communities and help create a retirement-ready nation through leadership in the retirement plan niche. Business owners often look to their advisors to implement 401(k) plans for their employees. Although some business owners choose to omit various 401(k) features, it’s up to us as the advisors to encourage and provide leadership to help the employer recognize their opportunity to make an impactful difference in their employees’ lives through what’s possible in the plan document.

Here are three 401(k) features that help change communities, especially those with lower incomes:

1. Automatic Enrollment

Automatic enrollment is essential to transform communities, including those in low-income, underserved areas. By setting up the plan with automatic enrollment, employers nudge employees to build better saving habits and, more importantly, help them get on track for retirement.

Some employers resist this plan feature because they feel their employees may resent them if the plan includes automatic enrollment. However, most times, the plan is set up with conservative yet meaningful salary deferral defaults from 3% to 6%. While some may argue that 3% to 6% is not enough to save for retirement, it’s at least a start, especially for those who may not understand or recognize the importance of saving.

Our team typically recommends starting at 5% as studies show that the enrollment rate does not materially change between 3% to 5%. It’s important to note employees always have the option to opt out of the plan if they don’t want to save for their retirement. Employees also have the option to save more than the default amounts if they prefer.

For the occasional employee who forgets to turn in the paperwork to opt out, the plan can also include a feature that allows the money to be returned to the employee within a certain amount of time. Automatic enrollment not only benefits employees, but the employer may also benefit by claiming a tax credit of $500 if they add an auto-enrollment feature to their plan.

2. Automatic Escalation

401(k) plans can include an automatic escalation feature, which means each year, the employee’s savings rate automatically increases by a chosen percentage set forth in the plan document. As an example, the plan can stipulate the deferral rate to start at 3% with 1% annual automatic escalation up to 15%.

That means the following year, the deferral rate would automatically increase to 4%, then 5% the next year and so forth until the employee is saving 15% of their salary. Automatic escalation is key to helping employees continue saving more and more each year as their salaries typically increase with inflation on an annual basis. Employees always have the option to opt out of the default plan settings or elect other saving options that they feel are in their best interest.

3. Automatic Reenrollment

Automatic reenrollment is what it sounds like. It’s basically automatic enrollment that reoccurs each year, meaning that if an employee initially opted out of the plan, then that person would be automatically enrolled at the beginning of the next plan year.

This is important because it essentially sweeps those who elected not to save for whatever reason into the plan. It gives employees another opportunity to start saving for their retirement without having to fill out any paperwork.

These three plan features play off behavioral finance and inertia. As advisors, we all have experienced some clients or prospects who delay making important decisions because it requires them to act in some capacity. When an employer uses the 401(k) plan's automatic features, employees are defaulted into the right saving decisions that take little to no effort on their end.

More effort is required if they want to opt out of the plan.

The more important question is, how do 401(k) plan design and implementation change outcomes for disadvantaged, low-income and minority communities? For starters, low-income individuals may be eligible for a 10% to 50% Saver’s Credit if they contribute to their employer-sponsored retirement plan.

Moreover, we often have seen enrollment rates between 90% and 100% when the plan is set up with the proper features. On a national average, only 25% of plan participants are generally on track for retirement, but when the plan is designed with an understanding of behavioral finance, then these metrics tend to increase to over 67%.

From time to time, metrics for those on track for retirement are over 90%. Many of the state IRA programs are structured with these same ideas in mind. For instance, the State of California’s CalSavers program has currently achieved a 70% enrollment rate implementing these three program features.

By understanding how these simple automatic plan features work, financial planners can fundamentally change communities and help create a retirement-ready nation.

Amie Agamata is a Certified Financial Planner in San Diego, Calif. Amie serves as the NexGen President for the Financial Planning Association of San Diego and is a member of the FPA Retirement Income Planning Advisory Council. She may be contacted at [email protected].