Automatic Escalation

Strengthen employee saving habits with regular deferral increases

An earlier blog entry that focused on automatic enrollment discussed how this modern retirement plan feature simplifies the enrollment process for employees. It also noted that automatic enrollment is as effective as it is convenient: Participation rates among Ascensus plans that adopt automatic enrollment are almost 10% higher than those in plans that don’t.¹

Encouraging responsible savings habits can certainly start with automatically signing employees up for a plan. Once enrolled, however, most employees are content to simply leave their default deferral percentage—often between 3% and 4%²—untouched. More is needed to get them to prepare for the future through the use of higher deferral rates.

Today’s retirement plans utilize automatic escalation to boost savings rates among employees instead of relying on manual deferral increases that are unlikely to be elected.

Automatic escalation allows employees to gradually increase their deferral rates over time. The increases needn't be dramatic—upping deferral rates by just 1% each year can have a meaningful impact on retirement savings balances. When deferral rates are raised in tandem with an annual increase in pay, employees are less likely to notice the effect it has on their paychecks.

Support for automatic escalation of deferral rates has been growing. Ted Benna, creator of the first 401(k) retirement savings plan, has stated that he would make it mandatory for every company with such a plan to automatically enroll employees at 3% of pay and automatically increase that number by 1% every year to a maximum of 10%.³

Research conducted by WorldatWork and the American Benefits Institute suggests that Mr. Benna’s recommendations are being heard, as a survey of employer-sponsored retirement plans showed that 97% of companies that offer automatic escalation increase the default by 1% each year.⁴

At the employee level, plan features like automatic escalation can significantly affect how savers view their retirement security. Recently published findings by Putnam Investments revealed that employees using auto escalation were more confident about their retirement than those who didn't use the feature. In addition, households using automatic escalation had higher investable assets and a slightly higher average deferral rate.⁵

Plans that use automatic features are likely to see improvement in helping employees save for retirement. Automatically enrolling employees and gradually increasing their salary deferral rates over time can put them in a better position to achieve retirement readiness.

1 As of February 1, 2012.

2 Source: WorldatWork and the American Benefits Institute, "Trends in 401(k) Plans and Retirement Rewards." March 2013. http://www.americanbenefitscouncil.org/documents2013/abc-waw-surveytrendsin401kplans-2013.pdf.

3 Source: Kujawa, Patty. Workforce, "A ‘Father's' Wisdom: An Interview With Ted Benna." January 20, 2012. http://www.workforce.com/articles/a-father-s-wisdom-an-interview-with-ted-benna.

4 Source: Source: WorldatWork and the American Benefits Institute, "Trends in 401(k) Plans and Retirement Rewards." March 2013. http://www.americanbenefitscouncil.org/documents2013/abc-waw-surveytrendsin401kplans-2013.pdf.

5 Source: Van Harlow, W. Putnam Investments, "Lifetime Income Scores III: Our latest assessment of retirement preparedness in the United States." April 2013. https://www.putnam.com/literature/pdf/DC939.pdf.

Third-Party Benchmarking Services

Present employers with an easier way to measure value for cost

In 2012, the Department of Labor (DOL) issued rules requiring certain retirement plan service providers to clearly and effectively communicate expense information to employers and employees. The goal of this disclosure was to assist plan fiduciaries with understanding the costs for services provided.

The requirement offered financial professionals a unique opportunity to demonstrate their skills and expertise in terms of making it easy for employers to analyze and compare providers.

To take advantage of that opportunity, some have engaged third-party benchmarking services to help employers conduct a thorough review of service providers for their retirement plans. Main areas of focus include recordkeeping services, trust services, and the plan’s investments. In addition to looking closely at expenses, the range and quality of services provided is taken into consideration.

While third-party benchmarking services don’t completely replace traditional evaluation practices, they can offer a more cost-effective and objective way to carry out and document a prudent retirement plan review. In the past, financial professionals had to take on cumbersome reviews alone, usually by soliciting and analyzing requests for proposals (RFPs) from a number of providers. This involved sifting through copious amounts of data to determine if there was good value for cost.

Since RFPs didn't always provide a true “apples-to-apples” comparison of plans, this proved to be an arduous task. The questions were standardized, but the responses varied greatly. In the end, financial professionals and their clients were left to seek additional information elsewhere or make judgment calls without complete certainty.

Today, third-party benchmarking makes it easier to obtain:

• Plan comparisons that show what an employer is getting relative to what is happening in the marketplace in similar plans
• Facts that are broken out to objectively analyze:
• Plan design features
• Employee success measures
• Employer and employee services
• Documentation for fiduciary purposes

The recent emphasis on fee disclosure has made third-party benchmarking services a valuable tool for comparing pricing among providers, as the information provided can go a long way toward helping financial professionals and employers choose the most appropriate services for their plans.

According to independent investment consulting firm NEPC, vendor comparisons in 2011 resulted in savings, on average, of 40% on recordkeeping costs.¹ Furthermore, a study by human resources consulting firm Aon Hewitt found that 52% of defined contribution employers are interested in working with a third-party benchmarking service in 2013 to compare fund, recordkeeping, and trustee expenses. This is up from 35% the previous year.²

In addition to potential cost savings, third-party benchmarking services can help satisfy DOL and ERISA fiduciary requirements, as they demonstrate that a prudent process has been followed for:

• selecting and monitoring plan investment alternatives and plan service providers; and
• ensuring that service provider costs and other plan expenses are reasonable in light of the level and quality of services provided.³

The current regulatory and legal environment has made financial professionals and their clients more accountable for determining the reasonableness of expenses and the suitability of investment offerings. Third-party benchmarking services can assist them in satisfying their fiduciary obligations by providing the data that can help them analyze the elements that will ultimately lead to successful plan operation and high-quality service. 

1Source: NEPC’s Defined Contribution Practice Group’s 2012 Plan & Fee Survey.

2Source: Aon Hewitt, 2013 Hot Topics in Retirement

3Source: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Fees

Investment Fiduciary Programs

Provide guidance that maximizes fiduciary protection for clients

Retirement plan fiduciaries are
held to high performance standards and are legally accountable for many aspects of plan oversight. This includes the
time- and resource-intensive endeavor of conducting continual due diligence on the investments offered by a plan.

In the past, this responsibility was shouldered by employers, despite the fact that they were completely unfamiliar with this type of research. This was particularly problematic for small business owners, as many weren’t even aware that they were acting as fiduciaries when it came to selecting and monitoring their plans’ menus.

Today, financial professionals can help employers of all sizes manage their fiduciary exposure by offering investment fiduciary services, either directly or through a third-party vendor.

Providing fiduciary protection can help employers manage risk related to a retirement plan’s investments, and are typically conducted by financial professionals and/or independent investment consulting firms that specialize in manager due diligence and asset allocation.

These individuals and firms assume fiduciary responsibility for identifying and monitoring suitable investment options for retirement plans, taking into account items such as investment performance, organizational changes, style consistency, and expenses.

A program that manages fiduciary risk offers several benefits, including:

• Years of specialized experience—Financial professionals and independent investment consulting firms have insight into areas that are mostly unknown to individuals acting as fiduciaries.
• A degree of safety—Protection may be provided for employers against certain claims and expenses brought about by employee lawsuits.
• Improved investment selection—A formal process for protecting against fiduciary risk helps ensure that employers create an appropriate investment menu through documented procedures. 

Two of the most popular approaches to providing investment fiduciary protection are designated 3(38) and 3(21) fiduciary protection. The primary distinction between the two is discretionary authority over the selection and monitoring of plan investments.

3(38) Fiduciary Protection	3(21) Fiduciary Protection
Level of Protection
A financial professional or consulting firm assumes full fiduciary responsibility and discretion for the plan's investments and acts as an investment manager.	A financial professional or consulting firm shares fiduciary responsibility with an employer for the plan's investments.
Investment Selection
An employer selects the initial investment menu from an approved fund list options. A financial professional or consulting firm manages the menu from there.	An employer creates the investment menu from the approved fund list. A financial professional or consulting firm provides recommendations for how to update it going forward.
Best for
Employers looking to hand over control of ongoing investment decisions in return for complete fiduciary coverage.	Employers who want to stay involved in the investment selection process while reducing fiduciary liability.

With the Department of Labor currently working to re-define what it means to be a fiduciary, there’s a strong possibility that investment fiduciary services will gain greater prominence in the retirement plan landscape. In fact, all asset managers in a Cerulli Associates survey of investment-only managers expect this to be the case.

For retirement plan fiduciaries that are required to always act in the best interests of plan participants, investment fiduciary programs offer reduced risk exposure and a simple way to oversee a plan’s investments. They also provide an added layer of independent protection that allows financial professionals to provide both the guidance their clients depend on and the coverage their clients seek.

1Source: Cerulli Quantitative Update, U.S. Retirement Markets 2012.