The 401(k) retirement plan is the principal retirement savings mechanism for many Americans. Almost 80% of all Americans have access to a workplace sponsored 401(k) plan. With total assets of nearly $5 trillion, these plans present a tremendous opportunity for the average worker to save for a healthy retirement with an employer’s support.
However, every opportunity presents challenges. For a 401(k) plan, these challenges include low participation and inadequate deferrals. The employer’s retirement plan may be the main source of retirement income, yet too many workers either do not participate or contribute at levels that won’t allow them to maintain their standard of living in retirement.
The problem is participant apathy. Advisors need to understand participant apathy, including its causes and potential solutions. Doing so can help advisors grow their business while better serving their clients.
The Problem: Participant Apathy
Most Americans think about retirement, and all Americans want to have a secure retirement in which they can maintain a comfortable lifestyle and pursue the activities and goals that are important to them. Saving for this type of retirement requires forethought and discipline. For most people, this means using an employer sponsored 401(k) plan.
Unfortunately, even though people want a secure retirement and have a means of saving, many do not participate in their company’s retirement plan. According to the US Census Bureau, 59% of eligible employees are not participating in a 401(k) plan. And those who do participate rarely contribute enough to meet their retirement goals. In an analysis of its own defined contribution plans, Vanguard found the average contribution is only between 6% and 8%.
Participant apathy is troubling. Most people genuinely want to save for retirement, yet they fail to take the necessary steps to do so. What forces are hindering participation and contribution levels?
Human Behavioral Tendencies
One force working against 401(k) participation is human behavior. The field of behavioral finance sheds light on how human nature affects our financial decisions, including saving for retirement. Research in this area has revealed two tendencies that explain participant behavior.
First, people have a natural tendency toward inaction. Although workers know that participating in a retirement plan is beneficial, many simply do not join. Knowing this, plan designers have introduced auto-enrollment features. Rather than having employees opt into a plan, auto-enrollment has all employees participate by default. Workers may choose to opt out, but they are unlikely to do so given our natural tendency toward inaction.
Second, people tend to give greater weight to recent events than to events in the future. How does this play out in retirement savings? Participants think, “I’ll increase my contribution next year.” But when next year arrives, they don’t follow through because they perceive more pressing present needs for that income. Plan designers are overcoming this tendency through auto-escalation, which automatically increases participant contributions each year. By removing the need to make a decision each year, auto-escalation increases retirement savings.
Auto-enrollment and auto-escalation mitigate negative human tendencies, but they aren’t the end-all. While they remove certain challenges presented by human behavior, they do not engage participants in their retirement planning. For that, education is key.
Lack of Engagement
Another force working against 401(k) participation is a lack of engagement, which is often attributed to plan advisors’ reliance on ineffective retirement education methods. Many participant meetings simply fail to engage attendees. Too many advisors distribute generic brochures with general plan information and then talk about murky concepts like asset allocation and plan fees. They conclude by suggesting that employees log into the retirement plan web portal to see their information.
The employees, who have a natural behavioral tendency toward inaction, have just sat through a boring participant education meeting, and now they are put in the driver seat and expected to seek out more information online. Is it any wonder that these efforts don’t increase participation in the 401(k) plan? It does not make sense to ask people to go to a web portal, review their balance and contributions, and take the initiative to make changes.
What these plans need is advisor-driven education that engages and motivates employees to take action in the simplest, most convenient way possible. Stay tuned for our follow-up post: Better Participant Outcomes: The Solution.