June 12, 2012

4 Ways to Use Behavior in Shaping a 401(k) Plan

Diversified Retirement white paper lays out best practices for retirement plans that help employees reach savings goals

A Diversified paper lays out how to use behavior to help employees meet their retirement savings goals. A Diversified paper lays out how to use behavior to help employees meet their retirement savings goals.

When the time comes for retirement plan sponsors to develop a new 401(k), it’s all about communication and education.

So says Diversified Retirement Corp. in a new white paper, “Effective Communication Begins With Purposeful Plan Design,” released Monday by the Harrison, N.Y., retirement plan provider.

The paper includes four best practices to help sponsors ensure that their 401(k) or other retirement plans are truly designed to help employees achieve their savings goals.

“Effective participant communication is essential to a successful retirement savings plan, but not even great communication can make up for poor plan design,” said Patricia Advaney, Diversified’s senior vice president of participant solutions, in a statement. “To communicate with purpose and positively impact participant behavior, plan sponsors must review their plans on a regular basis to ensure all features are working in tandem to support key objectives.”

And, according to Diversified, learning to understand and shape participant behavior is essential for plan sponsors who want to help employees save for a well-funded retirement.

Here are four ways to make that happen:

Implement automatic enrollment to optimize the benefits of your plan

1) Implement automatic enrollment to optimize the benefits of your plan.

More than half of all plans that automatically enroll employees use a default deferral rate of 3% or less.

“Don’t follow the crowd,” says Diversified. “Instead, consider setting a default rate that is at least as high as your current opt-in rate and integrate automatic escalation to improve participants’ retirement readiness over time.”

Design employer contributions to maximize your plan’s objectives

2) Design employer contributions to maximize your plan’s objectives.

Studies have shown the impact of matching contributions on savings rates. But despite what those studies say, many sponsors default to standard formulas such as a 100% match up to 3% of pay or a 50% match up to 6% of pay.

“If increasing the average savings rate is a key goal for the plan, consider extending your match to 25% up to 12% of pay,” Diversified suggests. “In many plans, the rate at which the match is maximized is the most commonly chosen participant contribution rate. Stretching this incentive will likely result in higher savings rates.”

Narrow the number of investment options

3) Narrow the number of investment options you offer to employees. The number of available investment options is directly related to participation, according to the latest retirement research. Plans that offer 10 to 14 funds have the highest participation rates, but participation rates decline as more funds are added.

“While retirement professionals may appreciate the subtle differences among asset allocation plans, target date funds and one-decision investing solutions, the average participant does not,” Diversified says. “For many participants, more options implies more work.”

Limit the loans!

4) Limit the loans! Eighty-seven percent of all retirement plans offer loans and 47% of plans offer multiple loans.

“If your plan is falling short on average balances, loan activity is likely to be at least partly to blame,” Diversified warns. “If improving employee retirement readiness is a business goal for the plan, why not consider a change to plan design to limit—or eliminate—plan loans?”

Want a copy of “Effective Communication Begins With Purposeful Plan Design"? E-mail your request to: RetirementResearchCouncil@divinvest.com.

Read The Fight Over 401(k) Fees at AdvisorOne.

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