Most 401(k) participants sit through a single presentation by their company's retirement plan representative. They fill out a few forms, designate a beneficiary, and allocate their contributions to a few selected plans. After that, they may never take any action involving their 401(k) plan again. They think they are all set and don't need to worry about it until they are about to retire. However, the average employee may not be taking full advantage of the benefits offered by an employer-sponsored retirement plan.
While about 85% of eligible employees participate in their company's 401(k), that leaves 15% who are not participating. This is potentially costing employees money from matching employer contributions and tax-deferred savings. Employees who do not take part in their 401(k) may be less likely to make other retirement plans, leaving them without any source of retirement income other than Social Security and whatever savings they may have at the time of retirement. Participating in a 401(k) is the first step in taking advantage of the benefits.
Once an employee enrolls in a 401(k), they need to fund it with realistic contributions. The average salary deferral for participants is about 7%. The very minimum contribution any participant should make is enough to receive their employer's matching contributions, which averages about 4% of the employee's annual compensation. However, a contribution of 10% to 15% of annual compensation may be necessary to help employees set aside enough money to retire comfortably.
Many employees are inexperienced and uncomfortable with financial planning decisions. As a result, many 401(k) participants select the default investment options. For a younger employee, the default investment options may be overly conservative, yielding lower returns in the long run. Target-date funds are some of the most popular options to allocate funds. However, as with any fund option, investors should consider the fees involved and how those fees may affect their returns.
Employers often take the same “set-it-and-forget-it” approach as employees when it comes to selecting a 401(k) plan. Employers do not have the time or energy to regularly revisit 401(k) plan options or gauge employee success in retirement planning. Instead, they chose an average plan that requires minimal participation and maintenance. Employers may not think about the plan they are offering their employees for years. However, as a plan sponsor, you can take steps to provide your employees with a better way to save for their retirement and provide for their families. In fact, as a Plan Sponsor, you may very well have a fiduciary duty under ERISA to do so.
One change employers can make is increasing the automatic enrollment deferral contribution (or implementing an automatic enrollment feature if the plan currently lacks one). For those unfamiliar with automatic enrollment, employees eligible to participate in the plan are automatically enrolled in participation and have a default percentage of compensation withheld from pay and contributed to the plan. It is one of the best means of increasing employee participation in the plan, and also has the added benefit of assisting the plan in passing non-discrimination testing requirements. The average automatic deferral is about 4%. Employers could increase the default deferral to 10% or 15% to help employees start putting away more money for their retirement. Employees can always change their contribution amount or unenroll from participating in the plan entirely if they want more take-home money in their paycheck. However, starting them out with a more aggressive deferral rate can help encourage a successful retirement strategy. Moreover, it is a proven statistic that employees are more likely to participate when the plan has an auto-enrollment feature.
If you have any questions about your company's 401(k) or other employee benefit plans, Butterfield Schechter LLP is here to help. We are San Diego largest law firm focusing its practice on employee benefits law. Contact our office today with any questions on how we can help you and your business succeed.