People get excited about technology. There are hundreds of websites chronicling the next big thing in technology, presenting information about how a device will save you time and money while providing entertainment. Getting people excited about or even acknowledging a retirement plan is much more complex. Over the years, there have been several new features created to help participants by increasing the flexibility of how they fund their retirements. Participant inertia is a large problem and directly relates to the usage of these new features.
As retirement plan professionals we believe having a solid retirement strategy is a no-brainer. For us, it’s a partnership with the plan sponsor that leads to great results by getting them involved and sharing responsibility of communicating and educating the participants. Human resource professionals have direct contact with employees and a great understanding of the best communication mediums and incentives that drive employees to take action.
There are several tools available for participants to project their retirement income. One of them, PlanAhead for Retirement®, enables participants to input additional income sources and variables to project their replacement incomes. Through the PlanAhead for Retirement tool, there is also a retirement readiness report that provides clients a view of the expected retirement outcomes of their participants on a plan level. The retirement readiness report displays where participants fall in relation to their projected replacement income at retirement. The report allows the client to change several variables such as the target of replacement income, return on investment, and changes to employer contributions. This is further broken out by age, service, and participant contribution rate. This interactive report helps the client make the leap from using current data such as participation rate and average deferral rate to projecting the results in the future.
At a plan sponsor level, using industry-related statistics on participation rate and average contribution rates we can show plan sponsors how they compare to their peers. Any deficiencies in the peer comparison are consulting opportunities. Using their participant demographic data, scenarios can be created to determine how changes to plan design (i.e., adding or increasing employer match) or targeting communication to specific participants encouraging them to take advantage of the benefit provided will improve results.
At an employee level, the medium of communication and the timing of the call to action are also paramount. Coordinating the retirement plan education and enrollment at the same time as other benefit enrollment periods has advantages as the employee is already completing paperwork. Showing an employee general information on plan demographics can also lead to an increase in participation and contribution rates via competition. Inertia is present in all retirement plans. What better way to promote change than to make it a competition, albeit an internal one.
Getting a plan sponsor to act on a retirement plan is just as important as getting the employees to act. As retirement plan professionals, we know that developing a partnership with sponsors can help lead to great results, keeping employees on track and taking steps to more successful retirements—using that flashy new technology that makes it easier for everyone.
The balance between value and expense is often a large part of our daily considerations. As a consumer, when we look at the cost of a jar of peanut butter, we consider the quality of the product and the opportunity for satisfaction. The same rationale is true with retirement plans, though satisfaction as it relates to value in a retirement plan product is more difficult to define. At a base level, it could be as simple as answering the question, “Are the participants in the plan satisfied with their projected retirements?” At termination of employment, why does a participant feel the need to move their assets out of the retirement plan that they had previously relied on for several years?
With the new fee disclosure requirements, most plan sponsors are well aware of the costs involved to maintain their plans, including administration and trust/custody fees. These expenses are clearly defined in communications to the plan sponsor and participants. Also included is a listing of fund returns along with operating expense ratios (OERs) for the investments. The OER is the expense charged by the investment to the participant and can vary significantly, not only from fund family to fund family but by similar investments as well.
Savvy investors understand the important role of OER and how different share classes of the same investment can yield different results. Participants in a retirement plan are more likely to experience lower expense ratios than if they invest by themselves in an individual retirement account (IRA). To illustrate the expense, if a plan participant invests $10,000 in a fund with an expense ratio of 0.46%, the cost per year is $46. That same investment at a retail IRA level could have an expense ratio as high as 0.85% or $85 per year. That extra 0.39% in expense directly reduces the return on investment (or satisfaction) for participants. Which raises the question, why are participants so eager to leave the employer’s retirement plan for an IRA?
Perhaps having one investment advisor watch over your all of your retirement funds can be comforting to participants. The number of investment options increase when moving from a retirement plan to a retail product. And the termination of employment can lead to a feeling of separation with the company and retirement plan.
Providing participants detailed information on their post-employment options can help them make informed decisions to maintain retirement satisfaction. It is important for participants to know they may not be required to move their money out of their retirement plans. They may want to consider the expense and features of the plan compared to other investment vehicles and decide where they see the most value for their retirement dollars to maintain that level of satisfaction.
Contributing to a retirement plan is widely considered a no-brainer if the goal is to attain a meaningful retirement. But the decision on how to invest contributions within the plan can be daunting. Determining what type of contributions to make further complicates things. While tax-deferred contributions reduce taxable income in the year in which they are made, the taxes owed on those contributions as well as the investment earnings are deferred until a later time, possibly at retirement. Roth contributions don’t reduce current taxable income, but the tradeoff is no tax liability on the investment earnings when a distribution is taken (provided the individual is at least age 59½ and has held the account for at least five years).
The decision to contribute to a Roth 401(k) instead of deferring at a tax-deferred level is often based on an anticipation of changes to future tax rates. While this is a personal decision based on future income, several other factors should also be considered. The truth behind the decision is similar to other choices in life, more complicated than we’d like it. For example, the reduction in tax-deferred income can affect tax liability, possibly increasing refunds. If tax-deferred contributions increase a tax refund, how can the “newly found” money be taken advantage of? Depending on a person’s filing status, different advantages or disadvantages may exist.
None of us are fortune-tellers. It’s difficult to predict future income or tax brackets over a period of several years. It becomes even more complex when trying to anticipate things that are out of anyone’s control, such as politicians altering tax rates to address policy changes and deficits. Recent history underscores this fact with significant changes occurring at the top rate, ranging from 50% in 1982 to 38.5% in 1987, 28% in 1988, 31% in 1991, 39.6% in 1993, 35% in 2003, and settling at back at 39.6% starting in 2013 (with rates exceeding 90% at certain points in the last century). Accordingly, depending on when money is taken out of a retirement plan, the tax results can dramatically change over a period of years.
A diversified investment strategy has long been considered a way to optimize investment returns over time while reducing risk. A diversified tax strategy may be equally important. By utilizing tax-deferred and Roth savings options, tax liabilities may be mitigated, ultimately creating more flexibility to reduce individual tax burdens.
Most individuals are beginning the process of preparing their income tax returns this time of year—paying taxes later is not an option that presents itself. However, an item in the American Taxpayer Relief Act of 2012 has added the flexibility for retirement plans to allow individuals to choose to pay income taxes on their retirement accounts now, so that it won’t be necessary when they retire and begin to draw the money out.
That is the primary attraction of a Roth account. If your 401(k) plan currently has a Roth option, the good news is that you may be eligible for this conversion. However, it will require some research to determine if it’s the right decision for you.
At face value, the trade-off is simple. If you convert pretax dollars to a Roth account within your plan you are essentially taking a distribution, within the plan, and opting to pay taxes in the year of conversion at your current income tax rate. This, of course, leads to an increase in taxes that are due for that year, and may even increase the tax bracket you are in. Once done, the new Roth dollars and any future earnings will grow tax-free as long as you hold the account for at least five years and are at least age 59 and a half years old before you withdraw it from the plan. A word of caution: the conversion is irreversible and therefore requires some forethought and analysis.
The types of individuals that may benefit most from this include people who anticipate making a significantly higher income as they near retirement, or believe they will be in a higher tax bracket in retirement. Individuals who believe this will find that a Roth account may fill a need in their estate planning. It’s important to project how these changes will affect individual tax situations and to make sure the available resources outside of the plan are there to pay for the taxes now. Specific details on the new Roth conversion are still being researched and guidance is needed before most retirement plans will consider adding this provision.
As an employee you can consult your summary plan description or talk to your employer’s benefits department to find out if your plan currently allows Roth accounts and whether the plan will add the feature to allow you to convert your pretax dollars. It’s great to have options when it comes to saving for retirement because it’s within those options that you’re able to develop an effective strategy to meet your retirement goals.