Adding automatic features to 401(k) and other defined contribution (DC) retirement plans can significantly boost the retirement savings of middle-income workers in particular, but older workers remain vulnerable to retirement shortfalls, according to a white paper published on July 25, 2017 by the Defined Contribution Institutional Investment Association (DCIIA).

The paper, “Design Matters: The Influence of DC Plan Design on Retirement Outcomes,” presents the first set of findings of an ongoing project that explores the current state of retirement readiness in a post-Pension Protection Act of 2006 (PPA) defined contribution environment. Based on data analytics and simulation analysis provided by the Employee Research Benefit Institute (EBRI), researchers looked at the positive effects of automatic plan features and the negative effects of asset “leakage” on the retirement income adequacy of DC plan participants, as well as at opportunities for improving DC plans without additional legislative regulatory action.

The authors stressed the importance of recognizing that today’s DC system is dramatically different from the system that existed prior to the PPA, as the PPA facilitated the introduction of many enhancements to DC plans, including automatic enrollment, automatic escalation, and qualified default investment alternatives (QDIAs). They cited research showing that currently, 60% of large DC plans have automatic enrollment, 80% of plans with automatic enrollment also have automatic escalation, and 85.5% of plans use target date funds as the default investment alternative for non-participant-directed monies.

The report pointed out that the difference in retirement savings for workers in plans with automatic features, and those whose plans do not have automatic features, is dramatic, as middle-income workers who spend their entire careers in plans with automatic enrollment and automatic escalation are projected to experience significantly better outcomes than middle-income workers in plans without automatic features.

Researchers recommended, however, that plan sponsors also take steps to limit asset “leakage” through early withdrawals or loans, especially given that the risk of default on such loans is high when an employee terminates employment with an unpaid loan outstanding. The authors therefore advised plan sponsors to limit plan loans, hardship withdrawals, and cash-outs, noting that doing so has been estimated to increase projected retirement assets and income by almost 10% for participants who otherwise take advantage of these features.

The study thus concluded that since the DC system is already equipped with many of the tools it needs to drive better retirement outcomes, the current system can be improved even without additional legislative or regulatory action. The authors observed that even among employers that already sponsor DC plans, wider and more consistent adoption of tools such as automatic features and adequate initial savings rates could make a significant difference in the retirement income adequacy of current participants.

However, the authors also counselled plan sponsors to keep in mind that younger workers are, on average, in better shape than older workers; particularly older workers who did not have access to a defined benefit plan, and were participants in a DC plan that did not include automatic features and other savings-boosting measures prior to the PPA. They, therefore, stressed that the recent implementation of an optimal DC plan design will not necessarily ensure that workers who did not enjoy the benefits associated with automatic features over their entire careers will have adequate retirement savings.

From Benefit Trends Newsletter, Volume 60, Issue 9

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