Diagnose Your Retirement Plan’s Health Amid COVID-19
As a 401(k) sponsor, how would you describe the health of your company retirement plan today? Is it thriving, seriously ill or somewhere in between?
With the events of this year – COVID-19 and the new SECURE and CARES Acts – the annual plan assessment that is always important has become more essential. For employers whose plan year-end is December 31, now is the time to begin your review to ensure adequate time to implement changes to improve or restore plan health.
1. What Constitutes a Healthy Plan?
In defining plan health, many 401(k) experts turn to behavioral economist Schlomo Benartzi, who suggests a thriving plan is one in which 90 percent of participants are enrolled, the average deferral rate is at least 10 percent, and 90 percent of participants are invested in a portfolio that is managed appropriately for their age. In today’s blog, we’ll focus on engagement rates.
2. Information Gathering
To assess the health of your plan, you’ll need important data. Rely on your recordkeeper to provide enrollment and savings rates. Due to COVID-19, review data from a year ago as well as current data. You’ll also want to request information on loans and hardship distributions, again requesting current and prior year information.
3. Increasing Rates of Participation and Savings
After learning whether involvement in your plan has grown, remained the same or dropped, consider plan design features that could encourage participants to increase or – if impacted by COVID-19 – rebuild their engagement.
Consider automatic enrollment and re-enrollment. With automatic enrollment, new participants are automatically enrolled upon reaching eligibility at a plan-defined deferral rate. Now may also be the time to consider re-enrollment for all eligible participants, also at a plan-defined deferral rate. In both cases, participants must be provided notice in advance and may change the deferral rate or opt out. Most do not opt out.
Employer matches also encourage participation, as employees want to make sure they receive the money employers are offering and they may only do so if they defer to the plan at the rate necessary to receive the maximum match.
Matches can also be used to leverage higher savings rates. Employers can “stretch” matches to encourage larger deferrals. An employer willing to contribute 4 percent of pay might stretch out the rate at which deferrals would be matched, contributing 50 cents to match every dollar up to an 8 percent deferral rate (thus incentivizing participants to contribute 8 percent of their pay) rather than making a dollar per dollar match up to a 4 percent deferral rate (and thus incentivizing only a 4 percent participant contribution). Plans using a stretch match may need to undergo discrimination testing, so employers should seek guidance from Third Party Administrators as part of their consideration.
Another measure to encourage higher savings rates is automatic escalation. Participants who were automatically enrolled and remain in the default deferral may be escalated annually. Once again, they must receive advance notice of the escalation and have an opportunity to change their contribution rate or opt out of deferring altogether.
There are tax incentives to encourage automatic enrollment adoption. With passage of the SECURE Act, employers who first adopt automatic enrollment January 1, 2020 or later may take a $500 per year tax credit for three years after implementation. Additionally, the SECURE Act allows employers adopting auto escalation in a safe harbor automatic enrollment plan to escalate participant deferrals up to as much as 15 percent after their first year in the plan.
4. Considering CARES Act Distributions and Loans
With enactment of the CARES Act, employers have had the choice to adopt policies that would allow participants affected by COVID-19 to take larger loans and hardship distributions. It has been a hard choice for many sponsors, who recognized the difficulties faced by those who experienced illness or financial adversity due to the pandemic yet were concerned about participants depleting retirement savings.
As part of the analysis to determine plan health, sponsors will want to look at whether participants took COVID-19 loans and distributions, if they were available, or if participants took other loans or distributions. In considering the steps explored above to improve plan health, employers also should take a close look at financial education programs available through the 401(k) plan. A best practice is to offer broad financial education and encourage its use. Such education can help participants adopt prudent practices in all aspects of their financial lives, to include building savings outside the retirement plan to help them weather times of adversity as well as increasing their retirement plan savings.
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.