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401(k) plans: the gold standard for retirement income planning

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When it comes to planning for retirement, the 401(k) plan remains king. On average, clients expect it to produce a third of their retirement income, more than from any other source. And beyond the quantitative aspect, 401(k) plans are favorably perceived: Most participants are satisfied with their plans and consider the fees to be reasonable.

However, despite the popularity of these plans and the positive light in which they’re viewed by those who participate in them, many plan participants and business owners, particularly on the small end of the market, don’t fully understand how they work, nor do they understand how their 401(k) account translates into an effective retirement income strategy.

For the financial professional, this means significant opportunities to help participants better understand how to save and plan for retirement. It also means the chance to provide additional services to smaller businesses that may lack the resources to allow participants to take full advantage of a qualified plan.

Areas for improvement

A recent study by Guardian Retirement Solutions of the small-plan 401(k) marketprovides a snapshot of what’s on the minds of participants. The small-plan market can be generally defined as plans holding less than $10 million in assets, which comprise 90 percent of all plans.

By focusing on the actual experiences of participants, the study highlights specific improvement areas where financial professionals can add value to the retirement income planning process.

Retirement confidence may be misplaced

There’s a paradox among participants between the income ratio goals they’re targeting for retirement and their expectations for how they’ll live in retirement. Although participants seek, on average, to receive 95 percent of their current salary in retirement, many expect to work part-time in retirement, reduce their standard of living, or delay the age at which they retire. Financial professionals can help clarify the confusion that participants have and ensure their goals and expectations are consistent and aligned.

Education can improve outcomes

Plan participants have minimal knowledge of 401(k) plan concepts. While there’s general familiarity with some terms, such as contribution rate, vesting and account loans, there’s a lack of understanding about what they mean and how they can actually help attain retirement goals. For example, Guardian Life’s RetireWell Study indicated that half of participants do not understand vesting of employer contributions. This means it’s possible that employees might leave jobs without knowing the potential employer contributions they’re leaving behind.

Without understanding basic investment concepts like dollar-cost averaging, target date funds or target risk funds, plan participants are challenged to adequately save for retirement. Lack of knowledge may also mean lower engagement, which can negatively impact retirement planning.

Potential for higher contribution rates

The RetireWell Studyalso reflected that the vast majority of participants are not contributing as much as possible to their plans. Only 15 percent of those under age 50 are maxing out their contributions, while only 11 percent of respondents over age 50 were contributing as much as allowed.

Plan participants are also preoccupied with fund accumulation rather than on how the money they’ve accumulated will translate to actual retirement income. Fifty-four percent focused on their 401(k) balance but only 29 percent paid attention to the income their account can generate in retirement.

Financial professionals can encourage clients to increase their contribution rate by showing them how much more retirement income can be generated when they increase their contributions. When presented with information showing that their current contribution rate would only enable them to replace 50 percent of working income in retirement, 41 percent of those surveyed indicated they were likely to increase their contribution rates. Twenty-five percent of participants said they would increase their contribution rates if it meant achieving a 100 percent income replacement ratio.

Participants also said they were more likely to increase their contribution rates if they had:

  • A better understanding of available investments in their plan;

  • A financial professional show them how to invest assets;

  • Better education materials from the company servicing their 401(k) plan; or

  • Learned that others of the same age and income were saving a bigger proportion of their income than they were.

Small-plan participants are missing out

Participants in small work places (less than 25 employees) generally have access to fewer plan features and investment options than larger companies. Features such as matching contributions, the existence of planning tools, access to knowledgeable telephone reps and a fee-based managed account program are less common in smaller organizations. Small-plan participants are also less likely to be aware of investment options, such as target date funds, stable value funds and fixed rate accounts.

Small-plan participants aren’t always sure if they have access to a financial professional through their company 401(k) plan. In companies where financial professionals were both available and visible, they were seen as valued resources, and participants were comfortable considering them as a resource for retail products outside of the qualified plan. This suggests the need for financial professionals to be more proactive.

Opportunities abound

There are many ways that financial professionals can take advantage of opportunities in the small-plan market. One is to create a robust, ongoing education program focused on helping participants better understand their plan, their investments, and their income targets for retirement, leading to greater success and clarity about their future. An education policy helps ensure sponsors deliver plan specifics by providing a strategy for achieving goals and objectives.

Financial professionals may also seek to work with plan sponsors whose plans are in need of a tune-up. It’s a best practice for sponsors to benchmark the fees and services in their plan every three to five years to check for “reasonableness” and “necessity,” important components in the Department of Labor’s 408(b)(2) regulations. For plans that have been ignored, or where the current financial professional is inactive, a fairly frequent occurrence in the small-plan market, there is a clear opportunity to help sponsors improve the plan experience for participants.

Many platforms have evolved to make large-plan services available to the small-plan market at competitive rates. At the same time, small-plan sponsors are increasingly realizing the value of working with third-party support services and financial professionals.

There are more and better opportunities for financial professionals in the small-plan retirement market than ever before.