From what I tend to see, only about 20% of employees are on-track to replace their income before retirement, during retirement. The fallout from this can be devastating for the company and for the employee. Perhaps the employee needs to work longer than they want (an unpleasant circumstance for the employee and employer), perhaps they need to significantly reduce their lifestyle during retirement, or perhaps they hold you responsible for not doing enough to help them save. Regardless of the possible future consequence, how do we as fiduciaries take this 20% on-track rate and turn it into 80%?
Let’s say an employee is about two years away from retirement and they go to meet with a financial advisor. This advisor tells them they’ll need about $500,000 to replace their pre-retirement income during retirement. And, for many people, this amount can be even higher.
Well, imagine the employee in this scenario only has around $300,000. They may come back to you, their fiduciary, and express concern. They may tell you they feel as if you didn’t properly prepare them, saying they never knew they weren’t on track. Worse yet, they may try to hold you responsible.
In most cases today, employees are contributing to “opt-in” 401(k) plans. In this kind of plan, companies ask their employees if they want to contribute or help them to understand how much they need to contribute. There are really no metrics to help them understand that they must increase their contributions over time.
Today, I want to talk about an alternative to this route: the “opt-out” 401(k) plan. This is something my team and I recommend that all clients adopt. When your new employee is eligible for the plan, they are automatically enrolled at 6%. Each year after this, their contribution rates are automatically escalated by 1% a year until they reach something like 10%. And, they are automatically defaulted into the qualified default investment alternative, which is typically a target-date fund consistent with when they’re going to retire.
The “opt-out” 401(k) plan can also help you improve the retirement outlook of employees who have been with you for years. Employees who aren’t at 6% will be bumped up to this rate, and employees who are at 6% or higher will be escalated until they reach 10%. Then, similar as new employees, they will be defaulted into the qualified default investment alternative.
Of course, employees can opt out of one or all of these features before they happen. They are in complete control, but inertia shows us that most people will allow this plan to continue.
If helping your employees stay on-track for retirement is important for you, you may be interested in our Plan Navigator Report™. This report helps you understand the impact of adopting the “opt-out” 401(k) plan features.
If you have any other questions or would like more information, feel free to give me a call or send me an email. I look forward to hearing from you soon.