The average salary deferral rate among retirement plan participants is 7.4%, with those under age 35 registering an even lower average of 6.3%, according to a new report from The Spectrem Group, Chicago.
Financial advisors providing income planning advice offered their thoughts on how planners could help increase those deferral rates for employer plans.
“It is a matter of sitting people down and going through the educational process,” says Ryan Huey, a certified financial planner with Perryman Financial Advisory, Dallas.
Educating people about the value of tax-deferred savings can increase both the participation rate and the rate at which plan participants save, he adds. “Education is the way that planners can really add value.” And, according to Huey, it does not have to be advanced retirement savings concepts, but rather “401(k) savings 101.”
When dealing with clients whose companies match their contributions, the planner should explain that the client is “leaving money on the table” when he or she does not participate in a plan, Huey says.
Failure to defer income into plans, he continues, is due to lack of education and a bit to laziness. Many larger companies make it possible for their employees to do it online, Huey continues. People should defer before they become too accustomed to larger paychecks, he adds.
Huey, age 31, says he believes a lot of people his age are more aware of saving than their parents were when they were their children’s age. If deferral rates are lower, he adds, it may be because of an income discrepancy compared with older plan participants and a “pent-up consumerism” for those who have recently graduated.
Huey expresses surprise that the deferral rates quoted in the report are as high as they are, though he adds that he also believes deferral rates will increase. One reason he cites is that the new automatic enrollment provisions in the Pension Protection Act of 2006 will increase participation, although not necessarily the rate of participation.
In the 8 years he has been working with clients on retirement plans, Huey says he has noticed that clients are more aware of the need to save for retirement because of headlines about pensions going away.
In fact, according to the Spectrem report, one-third of young participants believe their household is not saving enough to meet their financial goals. Conversely, only 32% of both the under-35 and over-35 sets believe they are saving enough for retirement, the report finds.
The deferral rate for most people needs to be 10% or higher, according to Glenn Hottin, a certified financial planner with M&H Advisors, New Haven, Conn.
Financial planners need to regularly review the deferral rate with employees and not just treat it as something that is selected and forgotten, Hottin continues. Moving an employee from a 6% level to the 10-15% level of deferral that most will need is something that should be done in steps, he adds.
Education is the key, and it applies to plan sponsors as well as to employees, according to Hottin.
For instance, the new automatic enrollment feature is a great tool, he says, but some plans do not include it for administrative reasons. These sponsors maintain it is easier for them to enroll people who are truly interested in the program than to enroll everyone automatically and then have to put through paperwork for those who opt out, he points out.
Employees must be educated about how any match will be lost if they opt out of the plan, he says.
The idea of “free money” is something employees respond to, he says. If they contribute 6% and get a 3% match, then even if you have to stay with an employer to collect that match, there is still the opportunity for a 50% return, he explains.
An employee must also be told about how the actual contribution is lower when tax benefits are taken into consideration, Hottin adds. For instance, if an employee contributes $100 and is in the 20% bracket, the person is really only contributing $80 for that $100, he says. Or, if an employee is in the 15% bracket, that employee is really only contributing $85 for that $100.
Another discussion point that seems to reach employees, he says, is the use of the story about 2 savers. Use it to explain the need to start saving early to take advantage of compounding, he says. The first saver saves $2,000 a year from ages 20-30 and then stops, accumulating $20,000. The second saver saves $2,000 from ages 30-65, accumulating $70,000. At age 65, the first saver will still have more money, Hottin says.
What seems to make less of an impression, he says, is the argument that by cutting out something basic each day, such as the price of a cup of coffee, an employee can find the money to defer. People want that cup of coffee, he says.
A dilemma that is built into the system and curtails deferral rates, he says, is the coupling of contributions rates of highly and non-highly compensated employees. In one case Hottin was working on, the highly compensated employees were limited to a 6% contribution because the non-highly compensated rate was 4%.
The reason is that the average deferral percentage test is satisfied where contributions for highly compensated employees is either 125% of the non-HCEs, or a flat 2 percentage points higher than the non-HCEs, according to Michael Kitces, a financial advisor and director of financial planning with Pinnacle Advisory Group, Columbia, Md.
However, a plan can avoid these restrictions in 2 ways, Kitces says. The plan can either make a qualified non-elective contribution for all eligible non-HCEs (3% or more of compensation, which can also be contributed for the HCEs) or offer qualified matching contributions (100% matching for the first 3% of elective contributions, and 50% matching on the next 2%, or some alternative matching formula at least as generous).
In the case above, a highly compensated employee earning $100,000 annually would not be able to make the full $15,000 contribution for 2006 allowed by the IRS, Hottin notes. (In 2007, the full amount increases to $15,500.)
Employees age 50 or older at year end would be eligible for a catch-up contribution as well, Kitces notes.
But for the non-HCE who earns $35,000 a year and has a family, Hottin continues, there isn’t “room in the budget to put anything away for retirement.”
In the case of the above firm, the sponsor limited access to employees because the owner did not want the employees to feel as if they were being sold a product, he says. However, if there were more access to employees, he says he feels participation would have been higher.
There is an alternative for companies that choose the safe harbor of making a 3% contribution across the board to all employees, Hottin says. For companies with 100 or fewer employees, this can be a viable option, he says. But for larger companies, it is costly, he says.
Joseph Birkofer, a certified financial planner with Legacy Asset Management, Houston, works directly with 45 plans. For those with a family income of $35,000 or under, deferral is not likely since “there is just no room in the budget,” he says.
But for those who are able, he says, he starts the enrollment session by handing out a piece of paper stating, “I want to contribute or increase my contribution to _,” and providing a number of percentage options. “You’d be surprised when you are confronted with a piece of paper, the response that you get.” He estimates that it works 60% of the time.
This helps solve 1 of 2 problems that prevent people from deferring money into plans: namely, not knowing how much to contribute and not knowing what to invest in, he continues.
People in fields in which employees rely on commissions or a salary that is less certain, such as waiters or bartenders, are less likely to respond positively to automatic enrollment, Birkofer says.
When working with employees, he says, the planner has to “bootstrap people and teach them in plain language and get them to see what retirement will look like and then work backward to show them how to get there.”
When you show them the numbers, you have to make those numbers personal, he continues. “People don’t sign up with charts, unless they are personal charts. You have got to make the numbers personal.”
For instance, he says, he recently spoke to a group of younger software programmers and asked them how they think their grandparents were able to retire. For employees in their 40s, he may ask the same question about their parents. “How are they affording the lifestyle that they are living? How did they get there?”
To make the point more relevant to employees, he notes that even though a 6% deferral sounds like a lot to many employees, it amounts to about a half an hour of pay a day. “There is definitely a half an hour in a day that you can carve out for yourself,” he says in his presentation.
Joel Larsen, a certified financial planner with Larsen-Financial, Davis, Calif., says, “Retirement plans are all about education.”
He cites an example of a golf course in Sonoma, Calif., with 66 employees, 48 of whom are eligible to participate in the retirement plan. Half of the employees do not speak English.
When he started working with the plan sponsor, the plan had 11 participants. But with some education and work, Larsen says the participation rate among eligible employees jumped to nearly 60% and the deferral rate grew to around 10%.
The first step is to make sure the plan works well and has a good portfolio, Larsen notes. Then, make sure there is proper education, he continues.
Some advisors rely on the financial institution actually creating the plan to provide support, but some of these companies are deciding not to offer field support for smaller plans. Larsen says he does not blame these institutions because he believes it is the advisor’s job to educate.
Typically when he starts working with a plan, there is a 50% participation rate. Often, he says, the “shine wears off a new plan,” with people stopping contributions or not increasing their participation rates.
In order to keep employees interested, he says, he holds after-work education sessions for both employees and spouses. When he explains the impact of not contributing to a plan, it produces results, he says. “There is nothing that drives enrollment like a worried spouse,” Larsen notes.
In the case of the Sonoma golf course, he says, he held information sessions in Spanish. Larsen also plans to have the capacity to offer information in Mandarin, going forward.
But the perspective that a planner brings may be the major way a financial advisor can help increase participation and raise deferral rates of plan participants, he says. “A retirement plan is not a product, but if you’re a peddler, it is,” he explains. The plan should be a low-margin business if an advisor is doing it right, he adds.
Where a planner can benefit is in the potential client base that can be built if participants trust the planner enough to seek financial advice, Larsen explains.
In his practice, he says, there is no “$1 million cut-off” requirement, such as many financial planners have. “The idea is to actually take time to make a difference.” That is what people respond to, Larsen emphasizes.