Just Out of Reish
Does your company sponsor a 401(k) savings plan or a 401(k) retirement plan?
AS A STARTING POINT, most 401(k) plans are savings
plans—OK for retirement, but not great. Some plans have
taken steps to become retirement plans, such as automatic
enrollment, automatic deferral increases, and investment
portfolios designed for retirement investing, like age-based
target-date funds or managed accounts. Those are some of
the criteria for evaluating whether a 401(k) plan is a retirement plan, but they are not enough to convert a savings plan
into a retirement plan.
What’s the difference? Here is my list of the key characteristics
of a 401(k) retirement plan:
Each participant knows how much retirement income a typical
retiree of the employee’s income level needs for a reasonable
standard of living. Most experts say that people need an
income replacement ratio of 75% to 85% of their final pay.
Part of that will be from Social Security—on average, about
40%—and, for most people, the balance will come from their
401(k) plans. (That is because most participants have few, if
any, other financial assets.) If you don’t know what you need,
how do you know if you will have enough?
In a retirement plan, participants also know how much retirement income their current 401(k) account will “buy” at retirement. (Alternatively, the estimated retirement income could
be based on both the current account balance and projected
future deferrals.) Each of your participants is on schedule,
behind schedule, or ahead of schedule in their retirement
savings. How can they calculate that? Most can’t; as a result,
participants need help from plan sponsors and providers. In a
“real” retirement plan, each participant is told whether he is
on course or not and, if not, what changes need to be made.
The calculation of the shortfall between current behavior and
the needed retirement amount is called “gap analysis” and is
available from some providers.
The key is that the participants be given the information—
for example, on their quarterly statements. Simply providing
Web site calculators hasn’t worked.
If participants are behind schedule, a 401(k) retirement plan
would tell them how much they must increase their deferrals
to get on schedule. Some providers already offer this service
and others will develop it—if the demand is there. Without
that information, how can participants accumulate the right
When this information is automatically provided to participants, it must be based on assumptions (which should be stated
clearly) and on the needs of the average or typical participant.
Of course, no participant is truly typical—or even average.
However, without that general guidance, participants will have
a hard time making decisions about their individual needs. It
is better to have the “solution” for an average participant than
no information at all.
If you don’t know what
you need, how do you know
if you will have enough?
Also, with that information, participants can better understand
that the long-term objective is retirement income—and how to
get to that income through saving and investing. Without the
information, success is largely a function of luck.
Of course, for participants who want to customize their retirement planning—for example, a later retirement age, a higher
savings rate, or a different investment strategy—the plan can
offer retirement calculators. Many providers already have
services to help participants with those calculations.
If your plan offers these services, you are sponsoring a 401(k)
retirement plan. If not, talk to your providers and advisers
about how to convert your savings plan into a retirement plan.
Fred Reish is Managing Director and Partner of the Los Angeles-based law firm of Reish & Reicher. A nationally recognized expert in
employee benefits law, he has written four books and many articles
on ERISA, IRS and DoL audits, and pension plan disputes. Fred
has been awarded the Institutional Investor Lifetime Achievement
Award and the PLANSPONSOR Lifetime Achievement Award.
He is also one of the 15 individuals named by PLANSPONSOR
magazine as “Legends of the Retirement Industry.”