Sprucing Up the 401(k)

With other retirement vehicles in dire shape, plan sponsors are rethinking their defined-contribution offerings.

Pity the prospective retiree. Social Security is projected to become insolvent in 2041, according to its trustees. Traditional pension plans are terminated, frozen, or underfunded with increasing regularity.

That leaves the 401(k) plan to carry the bulk of the retirement load. The trouble is, though, plenty of research suggests that 401(k) plans, as they are designed at most companies, do a poor job of providing for an adequate retirement on their own. A study by Hewitt Associates found that at companies that provide a 401(k) plan as the only source of retirement benefits, even employees who actively contribute to the plan could face a retirement-income shortfall of nearly 27 percentage points.

“You’re going to see a lot of companies that have employees who can’t afford to retire,” predicts Melodee Webb, vice president of compensation and benefits at Rockwell Collins Inc., an aerospace-design company in Cedar Rapids, Iowa.

Hence the quest for the perfect plan. Smart companies know that if they are going to rely more on 401(k) plans to provide the bulk of retirement savings, they have to make them work better. They are searching for ways to take the muss and fuss out of their plans and encourage more employees to participate.

To be sure, the right plan characteristics depend on the individual company’s goals. But widespread agreement on a number of best practices is emerging, regardless of the individual plan. The most often mentioned qualities are the presence of hefty employer matches, the right choice and number of funds, and helpful education and advice for employees.

Other best practices include using automatic enrollment, in which workers can choose to opt out of a 401(k) only after they’ve been dealt in; automatically hiking contribution rates on a yearly basis or when a raise occurs; and automating investment rebalancing to keep portfolios on target to meet retirement goals. “The best 401(k)s are often those with the simplest design features, both for the plan sponsor and for the participant,” says Karen Sanchez, a partner at Sikich Group LLC, a professional services firm in Aurora, Illinois.

Less Is More

During the late-1990s boom, many employers assumed that the way to get employees to put money into their 401(k) accounts was to offer them an ever-expanding array of mutual funds. The stock market’s upward spiral, they reasoned, would whet workers’ appetites for variety. Fund companies even began to offer brokerage accounts, enabling participants to bet portions of their retirements on any high-flying stock they desired.

Yet when the tech-infused bubble burst, that freedom turned out to be a curse for many plan participants as those risky stocks plummeted. And for others, a plurality of options just led to confusion. Indeed, research has shown that having too many options can actually deter employees from saving for retirement. What happens, according to Columbia University Business School researchers Sheena Iyengar and Wei Jiang, is that employees fall prey to “choice overload.”


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