The Automatic Retirement Plan
Within the past several decades, the amount of information available to everyone has exploded, not only overloading our senses, but introducing many new little decisions that have to be made on just about everything – often in areas we know very little about.
A good example is 401(k) plans and other defined contribution retirement arrangements where a participant has choices of contribution levels and investments. A minority of employees may still actually enjoy doing things the old-fashioned way, but many participants (and plan sponsors) would rather someone else make their decisions for them, or at least tell them what to do.
And this really makes sense. Unless you invest for a living or as a hobby, you have other things you want to do and at which you simply perform better. The unfamiliarity means that it’s hard to make decisions, and as we know with these kinds of plans, sometimes participants will simply shut down in the face of having to make these choices, and make no decision at all. This is the absolute worst thing they can do, because once they reach retirement age, they cannot go back and make up for the lost opportunity – it is too late.
The good news is that today’s automatic retirement plan is a lot more sophisticated than it used to be, so a participant can leave more of the driving to someone else, so to speak. In a properly-designed, fully automatic retirement plan, a long-term participant who does nothing at all still has a good chance at achieving a secure retirement.
In addition, once we’re through the COVID-19 environment (and indeed, in some ways we already are), plan sponsors are going to be looking for ways to bring participants back into the retirement plan and engage them after being furloughed or possibly just returning to more of a sense of normalcy.
What would a fully Automatic Retirement look like?
This is the first “automatic” feature that most think of when talking about retirement plans where an employee contribution is one of the main benefits. Automatic enrollment has been around for years. The basic idea is participants who don’t make an affirmative election get enrolled into the plan at a stated rate (e.g. 3%). This feature takes advantage of inertia, where doing nothing (the default position) results in being enrolled in the plan.
Automatic Contribution Escalation
Automatic escalation refers to a process by which a participant’s savings rate is automatically bumped up once a year, for example at each January 1, or when raises come out. While originally a feature of some automatic enrollment plans for participants who did not make an election, it has become a popular add-on, where participants may choose to have their contribution rates increased at specified intervals. Participants have a tendency to enroll (or be automatically enrolled) and stay at that rate for years. Adding this feature helps participants to save at increasing levels over time.
Automatically Diversified Investments
For plans offering investment choice (the majority these days), a typical default investment in a retirement plan has evolved from the old fashioned money market or stable value fund to a balanced-type fund (stocks plus bonds) or array of target retirement date funds. A participant who does not make an investment election will automatically get the benefits of diversification and automatic rebalancing, and maybe even an automatic glide path (see below).
We have all heard “buy low, sell high” in relation to investments. But really, in a retirement plan, a participant’s best bet is to pick a diversified asset mix and stick with it for as long as it makes sense. In the process of keeping that asset mix in balance, automatic rebalancing accomplishes “buy low, sell high” on a regular basis within that portfolio, by selling investments that have performed better and buying into investments that are currently lower priced, relatively speaking. This can be accomplished by arranging a fund menu into investment portfolio programs (one of which is chosen as the default), by offering an automatic rebalancing election on an existing fund menu, or within an investment itself, such as with a balanced or target retirement date fund.
Automatic Glide Path
Once again taking advantage of a participant’s tendency to leave things alone, a glide path changes a portfolio’s composition to become more conservative over time, as the individual gets closer to retirement. The classic way this has been done in the past is via target retirement date funds, but there are other options, such as investment portfolios that combine risk tolerance (conservative, aggressive, and in-between) with a glide path that takes participants down a risk scale from one portfolio to the next as the years go by.
Automatic Retirement Income
While participants still need to make an election at termination or retirement, here is one more area that can be automated. Monthly installment payments fell out of favor a couple of decades ago, but they are coming back into vogue as participants retire and want to convert their retirement balances into regular income. Today’s installment payments are more sophisticated and automated than in the past, and give participants who want to keep their money in the plan some more flexibility than they used to.
For a plan participant who likely doesn’t invest for a living or as a hobby, an Automatic Retirement Plan can be a great way to get on the right track from day one, or as participants re-engage in a post-COVID-19 environment. And as a plan sponsor who is concerned about employees being able to retire, an Automatic Retirement Plan satisfies the “do it for me” group who otherwise are not inclined to make the enrollment and investment decisions that are required by most retirement plans. Are you interested? Contact one of our experts today!
Investment Advisory Disclosure
All investment advisory services are provided through Conrad Siegel Investment Advisors, Inc., a fee-for-service investment adviser registered with the U.S. Securities and Exchange Commission serving as a fiduciary for its clients. Investing in securities involves the potential for gains and the risk of loss. Past performance may not be indicative of future results. Any testimonials do not refer, directly or indirectly, to Conrad Siegel Investment Advisors, Inc., or its investment advice, analysis or other advisory services.