Put your 401(k) to the test «
The debate continues to rage over which is better: a traditional defined-benefit plan or a defined-contribution plan, as in 401(k) and 403(b) plans.
In reality, fewer and fewer workers are likely to have a traditional pension plan—which many view as the most “efficient” type of retirement plan—and more and more people will have a defined-contribution plan.
And so the better debate to have would be about what features a best-in-class 401(k) plan should have. After all, if you’re going to have a 401(k) plan it might as well be a good one. But what features should it have?
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Well, according to at least one firm, it’s a bit of a mashup—the best of what a defined-benefit plan has to offer combined with the best of what a defined-contribution should offer. “If you design a defined-contribution plan that uses the same factors that make defined-benefit plans efficient, you get an efficient defined-contribution plan,” said Donald Fuerst, a senior pension fellow at the American Academy of Actuaries.
According to new report from the TIAA-CREF Institute, Equivalent Cost for Equivalent Benefits: Primary DC Plans in the Public Sector , the following elements make up a “best-practice, risk-managed” 401(k)/defined contribution plan:
•Mandatory participation or automatic enrollment
•Adequate contribution rates
•A limited set of professionally managed, low-cost, pooled investments
•Mandatory or default investment in automatic asset allocation vehicles, such as target-date funds
•Limited or no borrowing from the plan
•Annuitized benefit payments; and
•Provision of objective education and advice for participants
Are these the features that truly make up the ideal defined contribution plan? These features—perhaps with the exception of annuitized benefit payments and limited or no borrowing—are in line with what other groups and plan sponsors say make up a great 401(k) plan. “They have it substantially right,” said Fuerst.
But before you head down to your human resource/employee benefit department demanding that your plan add these features, there are at least two things you should know. One, not everyone seems to agree with the elements on the list. And two, not everyone wants what’s on the list.
While it’s possible to design what the TIAA-CREF Institute views as an ideal 401(k) plan, Fuerst says he don’t see many of them. “This is not the type of plan that (employers) or employees seem to want,” he said. “(Employees) want investment control and lump sums.”
What everyone seems to agree on
In the main, experts seem to agree that 401(k) plans, best-in-class or not, ought to have mandatory participation or automatic enrollment, and adequate contribution rates.
At the moment, however that’s not the case. For instance, just 67% workers with a 401(k) plan that don’t have automatic enrollment contribute to their plan, according to a report from the Center for Retirement Research at Boston College. Read How Does 401(k) Auto-Enrollment Relate to the Employer Match and Total Compensation .
What’s more, participants save on average just 6.8% of pay, according to 56th Annual Profit Sharing and 401(k) Survey from the Plan Sponsor Council of America (PSCA).
Plan sponsors and plan providers are moving in the right direction, but it’s still less than ideal. At the moment, 47.2% of plans now have an automatic enrollment feature and employees who participate in plans with automatic enrollment generally begin contributing at 3% of pay.
Ron Gebhardtsbauer, a professor at Pennsylvania State University, said enrolling workers at just 3% of pay is a disservice to employees, especially if they get stuck at the very-inadequate 3% of pay, and don’t even get the full employer match. “If employers are concerned about the cost of a higher default contribution, they can stretch their match by going to say 30% or 40% of the first 10% of pay,” he said.
And so what’s needed in a best-in-class 401(k) is an aggressive auto-escalation feature, advisers say. Currently, 57.9% of plans automatically increase the default deferral rates over time, according to the PSCA.