Frequently Asked Questions
About Retirement Made Simpler
What is Retirement Made Simpler?
Retirement Made Simpler is a coalition of respected advocacy, regulatory, and policy organizations, including AARP, the Financial Industry Regulatory Authority (FINRA), and the Retirement Security Project (RSP), launched to encourage employers to help their employees be better prepared financially for retirement. The campaign was created specifically to provide companies with the tools and information they need to automate their 401(k) plans, with the goal of encouraging more Americans to save for a secure retirement.
The campaign has developed tools and information to educate companies about automatic 401(k)s, why they work, best practices on how to implement them, and real- world experience from other companies that already have made the switch. Using the campaign’s Web site (www.RetirementMadeSimpler.org), the campaign’s Automatic 401(k) Toolkit (also available online), and ongoing outreach in targeted states, we give employers answers to their automatic 401(k) questions.
Which organizations have formed RMS? Why have they come together?
AARP, the Financial Industry Regulatory Authority (FINRA), and the Retirement Security Project (RSP) have come together because we know that Americans are not saving enough for retirement—and we can help. By combining our unique resources and our expertise, we are able to provide valuable tools that assist employers and their employees in saving more effectively.
We have devoted our resources to this campaign because we know that automatic 401(k)s work. Companies that use them commonly see participation rates soar to between 85 and 95 percent especially among workers with the lowest participation rates. Even better, it is easy for companies to automate their 401(k)s. With traditional 401(k)s, many employees fail to start saving because they don’t know how to allocate their investments or understand their choices. Saving for retirement seems so daunting that many people procrastinate or avoid thinking about it. But the inertia that keeps people out of traditional 401(k)s is used, in automatic 401(k)s, to help them save. When an employer takes the initiative to automate enrollment and set default investment options and savings levels, employees benefit. Employees start saving earlier, save more over time, and feel good about themselves and their company.
We are focusing our combined knowledge and resources on automatic 401(k)s because they are a simple and effective way to enhance retirement savings.
About Automatic 401(k)s
What is an automatic 401(k)?
It is a type of employer-sponsored defined contribution retirement plan in which an employee is automatically enrolled instead of having to sign up to participate. By taking the burden off of the employee, an automatic 401(k) greatly increases the odds of participation and can help an employee save more and save earlier in life.
Companies offering automatic 401(k)s do so by selecting a default investment (the standard fund in which all employees would automatically be invested) and a default savings rate (a standard amount that could increase gradually over time). Employees are automatically enrolled in the plan, though they can opt-out if they choose to do so. Employees also can increase or reduce their savings rate or change their investment mix at any point. Studies show that when companies automate their 401(k) plans, participation rates can increase dramatically.
How is an automatic 401(k) different from a defined benefit plan and traditional 401(k) plan?
If a company has a defined benefit plan, it provides a specific level of income for employees as a lifetime annuity or a lump sum. The amount of money employees get from a defined benefit plan typically varies depending on the plan’s benefit formula and the employee’s tenure with the company, age of retirement, and career average or final salary. Defined benefit plans, once very common, are increasingly being replaced by defined contribution plans.
A defined contribution plan also is an employer-sponsored retirement plan, but the income the plan provides is not predetermined or guaranteed, as it is with a defined benefit program. Rather, it varies according to how much the employee and employer contributes to the plan, how the contributions are invested, and the return on those investments. 401(k), 403(b), 457, and profit-sharing plans are examples of defined contribution plans.
An automatic 401(k) is a defined contribution plan, but it differs slightly from the traditional 401(k) plan in that employees automatically are signed up to participate at a predetermined savings rate, and in a predetermined investment. However, if an employee wants to change his/her savings rate or investment portfolio, or opt-out completely, he/she can do so without penalty. Automatic 401(k)s have been shown to increase the number of employees saving for retirement, help companies pass nondiscrimination testing, and increase employee satisfaction.
Do automatic 401(k)s work?
Yes, they do. It’s been well-documented that when workers are faced with overly complicated financial decisions, the tendency is to avoid making the necessary financial decisions required by a traditional 401(k). This dramatically increases the risk that they will be financially unprepared for retirement. The automatic 401(k) is a simple tool that takes the complexity out of saving for both employees and employers.
Automatic enrollment in a 401(k) has been shown to increase participation rates of newly hired employees dramatically, particularly among women, minorities, and low-income earners. When also applied to existing employees who do not belong to the 401(k) plan, automatic enrollment can increase participation rates to as high as 90 to 95 percent of eligible employees in an average plan.
Starting an Automatic 401(k)
Do automatic 401(k)s cost more to manage than my company’s current retirement program?
It depends. Costs could increase to some degree because of additional employer matching contributions (as a result of growing participation) and perhaps the time needed to manage more small accounts. However, matching costs are typically predictable and manageable, and reflect the fact that automatic enrollment tends to increase participation levels. In addition, matching contributions for automatically enrolled employees may be smaller than average because these typically are lower-income employees.
Fundamentally, providing employees with good benefits doesn’t have to hurt the bottom line—in fact, it can increase employee satisfaction and help with employee retention.
What if my employees can’t afford to participate in automatic 401(k) plans?
Conventional wisdom says that low-income people tend to have greater difficulty saving for retirement. Research from the Retirement Security Project (a member of the Retirement Made Simpler coalition) indicates that low-income individuals can, and will, save given the right circumstances. These include a significant and readily understandable employer savings match; easily accessible savings vehicles (such as an automatic 401(k)); and the opportunity to use part of an income tax refund to save. Professional assistance provided by an employer also could generate a significant increase in retirement-saving participation, even among low-income households. Of course, those who simply cannot save without sacrificing present needs can always opt-out of the plan.
For employees who decide they do not want to participate after enrollment has begun, the Pension Protection Act of 2006 allows them to get all of their contributions back without tax penalty, as long as they do so within 90 days.
A lot of my employees are low-income. How does an automatic 401(k) help them?
Automatic enrollment has been shown to raise 401(k) participation rates dramatically when it is applied to new hires, particularly new hires who are low earners. In one important study, automatic enrollment increased 401(k) participation rates of those making under $20,000 annually from 13 percent to 80 percent.
How do I select default settings for my automatic 401(k) that will be most beneficial to my employees?
Early on, many plan sponsors took a cautious approach to default settings, opting for low-risk alternatives geared to principal preservation (money market or stable value funds, for example). They were concerned about fiduciary liability—participant lawsuits over investment losses if, for example, the employer selected a default investment that involved stocks, and if the stock market declined.
Today, many sponsors are concerned about the risk to employee retirement security if an employee stays in a low-risk default fund for many years. The Department of Labor expressed similar concerns, and has issued regulations providing a measure of fiduciary comfort for three main types of Qualified Default Investment Alternatives (QDIAs)—lifecycle funds, balanced funds, and managed accounts. Surveys suggest that more than half of the automatic 401(k) sponsors are using a lifecycle fund or model portfolio, also known as a target date retirement fund, or a balanced fund or managed account as their default investment.
A lifecycle fund or model portfolio, also known as a target retirement date fund, is an investment mix that seeks both long-term appreciation (through equity investments, such as stock funds) and principal preservation (through fixed-income investments, such as money market funds), as well as risk management (through a diversified portfolio of stocks, bonds, money market funds, and even cash). Factors such as a participant’s age, expected retirement date, or life expectancy determine the investment mix. The mix becomes more conservative as the participant gets closer to retirement, usually by shifting assets from stocks to fixed-income investments, such as bonds.
A balanced fund or model portfolio is a similar diversified mix of equity and fixed income investments. A target level of risk for plan participants as a whole determines the investment mix. The mix is not required to vary with the age or other individual circumstances or preferences of particular participants.
Under a managed account, an investment manager provides investment management services under which it allocates the assets of a participant’s individual account. The goal is to achieve a mix of equity and fixed-income investments that seek both long-term appreciation and principal preservation. The manager uses investment alternatives available in the plan and adjusts the mix based on an individual’s age, target retirement date, or life expectancy. The mix becomes more conservative as the employee ages.
For additional information, please visit: www.dol.gov/ebsa/regs/fedreg/final/07-5147.pdf.