How to Choose the Best Options for Your Company’s 401(k) Plan
It takes more than portfolio diversification to help employees amass the money needed to enjoy life for 20 more years after they quit working full-time.
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Across the United States, 401ks were hammered by the financial crisis. Portfolio balances shrunk to a fraction of their former value, while many companies slashed matching contributions and participants swayed between panic and paralysis. After spending a significant amount of time reacting to market conditions, the faltering economy, and grappling with new legislation and regulations, plan sponsors are now returning their focus to improving their defined contribution plans, reports Callan Associates, an investing consulting firm headquartered in San Francisco.
The quality of your company's 401(k) plan will impact your employees' ability to retire with enough money in their coffers to sustain their retirement living. The fees charged by plan providers matters as does the scope and performance of the investments within the plan. The size of the employer match also makes a difference as to whether employees meet their retirement savings goals.
But the biggest driver in how successful your company 401(k) is is the savings rate. You can give employees the best plan providers, a wide selection of investment options, and the lowest fees, but if they don't save they aren't going to have enough money for their retirement, says Peng Chen, the president of the global investment management division Morningstar, the Chicago-based investment research firm. Figure out a way to encourage employees to save as much as they can. From there, 'make resources available to help them manage a diversified portfolio and choose the proper asset allocation to gain superior long term returns over time with as little risk as possible.'
How soon employees can retire with an income equivalent to 75 percent of earnings during their working years has a direct bearing on the highest ratings received by companies in BrightScope's top 30-list of the largest 401k plans. The San Diego-based firm analyzes retirement plans, which are rated on areas like average salary deferral rate, employee match structure, investment performance, and fees charged to participants.
Among the top ranking plans were United Airlines, Bayer, Credit Suisse, Exxon Mobil, and IBM. Big Blue's plan stands out compared with offerings from most companies. It boasts $27 billion in assets, 92 percent employee participation among more than 100,000 US employees, and an average employee balance of $127,000, more than double the national average. The success of IBM's and other company-sponsored 401(k) plans can be attributed to four key driving factors.
How to Choose the Best Options For Your Company's 401(k) Plan: Employee Contribution and Employer Match
Structure your company 401(k) plan in a way that it encourages the highest amount of savings. Studies show that automatic enrollment and auto-escalation are features that significantly increase 401k participation and savings. Automatic enrollment puts workers into retirement plans unless they opt out while auto-escalation increases contributions along with raises in pay unless employees opt out. Allowing for new hires to start contributions from the get-go instead of waiting a year for eligibility also helps in cutting back on lost time for participant savings.
At a time when companies were cutting matching contributions, IBM matches dollar for dollar up to 6 percent and offers automatic contributions up to 4 percent. The typical company match is 50 cents on the dollar up to 6 percent of pay. Some employers will match 100 percent up to 3 percent of pay. But getting employees to contribute closer to 6 percent is going to help them get their retirement income faster, says Mike Alfred, BrightScope's co-founder and CEO.
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How to Choose the Best Options For Your Company's 401(k) Plan: Fees and Plan Structure
IBM has an unbundled plan structure in order to leverage the management expertise of several plan providers and assemble the best investments at the best prices. 'You will see this more with the larger plan sponsors like our selves,' says Ed Adams, IBM's manager, defined contribution investment strategy. 'We have a separate record keeper, a separate trustee and separate investment manager. We don't believe that one company can be the best in all areas.' Unbundled plans help reduce participant costs, spread fees more equitably, and increase investment flexibility.
Smaller employers tend to go with the bundled plan structure, a one-stop-shop where a single company provides all investment, recordkeeping, administration, and education services. Bundled packages are not always cheaper since fees can be deeply buried. Smaller companies should consider hiring an independent investment advisor to help construct and manage an unbundled or partially bundled plan.
A key area of focus for plan sponsors must revolve around making sure fees are reasonable, well monitored, and clearly communicated to participants. A particular fund's past performance is not an indicator of future performance; it is the level of fees that will affect future returns, says Alfred. 'If you are paying 2 percent in fees and someone else is paying 20 basis points, no matter what your investment returns are over 30 or 40 year work period, those extra fees you are paying are going to slow you down,' he explains.
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