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.
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.
Dig Deeper: How to Launch Your Company's 401(k) Plan
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.
How to Choose the Best Options For Your Company's 401(k) Plan: Fund Selection and Diversification
A good 401k plan starts by having a lineup that helps employees build good portfolios. 'Most plan providers these days have an open architecture; they have hundreds if not thousands of funds to choose from,' says Chen. You want to offer at least 20 different investment choices. 'That gives enough coverage among the major asset classes employees would need to invest in to build diversified portfolios.'
Include the core asset classes: stocks, bonds and cash equivalents such as money markets along with real estate and international holdings, mutual funds, and exchange traded funds. Offer further breakdowns within the asset classes such as growth stocks, value stocks, small, mid, and large cap stocks, government bonds, corporate bonds, municipal bonds, short-term and long-term bonds, emerging market stocks, and emerging market bonds. Don't overlook alternative asset classes such as precious metals, commodities, and some other investment that doesn't move in the same direction as the stock market, says Ivory Johnson, director of financial planning at Scarborough Capital Management, a boutique wealth management firm in Annapolis, Maryland, which manages company sponsored 401(k) plans from Fortune 500 clients to small businesses.
'The way you reduce volatility is to have asset classes that move in different directions,' says Johnson. 'Large caps, mid caps and small caps go up and down around the same time although at different rates. The key is to have sufficient diversification. You can't have a diversified portfolio if all you are offering is three asset classes and maybe an international fund.'
Also consider default options such as target date funds, retirement managed funds or balanced funds. Target date funds automatically adjust the weightings of asset classes within the portfolio overtime to become more conservative as the employee gets closer to retirement age. To hedge against inflation, more plan managers are adding Treasury Inflation Protected Securities (TIPS). The principal of TIP increases with inflation.
IBM provides investment options in four different tier groups. Tier 1 is a broad fund category that includes target and risk-based funds for participants who don't want to get too involved in the selection process. Tier 2 is custom funds representing US equities, non-US equities, bond funds, real estate investment trusts and other broad asset classes. Seven funds are available in this category. Tier 3 is standard choice, which has a narrower focus of large cap, mid cap and small cap funds, growth and value funds, and IBM company stock. There are 11 funds in this category. Tier 1, 2, and 3 are IBM's core options, says Adams. 'None of these are mutual funds but rather commingled trusts or separate accounts. Most of these funds are passively managed index funds.' Given IBM's size, Adams notes the company is able to get extremely low expense ratios. Tier 4 is a mutual fund category that gives participants access to actively managed funds from brand name companies. 'This lets employees go into sub sectors like foreign funds or convertible bonds,' Adams says. 'We have 165 funds within that category.'
How to Choose the Best Options For Your Company's 401(k) Plan: Employee Education and Financial Advisory
A little education can go a long way in helping employees better manage their 401(k) accounts. It is always good to get advisors to come in and provide financial education for your employees, says Johnson; they can be affiliated with your plan provider or an outside firm. Doing so could increase employee contributions as well as protect the plan sponsor from litigation, Johnson adds. 'When it comes time for them to retire, if the market is down employees are going to look for someone to blame; they aren't going to want to take personal responsibility for managing their portfolios. So, the best way to limit your liability is to provide employees access to third-party advice and to hold seminars that explain the various investment options in your company's 401(k) plan.'
In addition, consider features proven to add value like financial engines that automatically rebalance a portfolio's asset allocation to help reduce risk. For instance, as an employee gets closer to retirement age, risk is reduced by selling off equities and buying more fixed income investments within the account. Some investments have built-in rebalancing such as target-based funds.
IBM provides access to financial engines that run retirement checkups. Using web seminars and modeling tools employees can estimate what retirement livelihood they are looking for and receive advice on how they should invest their retirement funds. IBM also offers money coaches through its MoneySmart program, allowing for unlimited one-on-one sessions between plan participants and independent non-commissioned financial advisors.
Employees can seek advice on just about any aspect of their financial lives and assets outside of their IBM 401(k) accounts. 'These counselors are very familiar with our plan and can address various financial situations, whether that is planning for retirement, saving for a child's college education, or dealing with caring for an elderly parent,' says Adams.