Best Practices: Plan Success by the Numbers (Part 1)
I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.
This is the seventh of the series about Best Practices for Plan Sponsors.
Most companies have budgets for their business operations . . . and then regularly compare budget-to-actual. In other words, they compare their actual expenses to the budgeted amounts to see if they are on track to accomplish their financial goals. That’s pretty standard, and there is nothing remarkable about it. But, why don’t plan sponsors and fiduciaries, for example, plan committees, use that same approach for their 401(k) plans? I have a theory about that. But, before I explain my theory, let me say that I believe that plan committees should have budgets, or goals, and should measure their success in reaching those goals.
My theory is that 401(k) plans don’t set goals for plan success because 401(k) plans were originally viewed as the “employees’ plan.” The idea was that employees could do what they wanted to do, since the plan was a supplemental savings plan. That approach made sense when pension plans were more popular. However, now that 401(k) plans have become the primary retirement plan for most employers and employees, it seems fairly obvious that the burden of success of 401(k) plans needs to fall primarily on employers and fiduciaries.
That is, in part, a legal burden. However, it is also a societal burden. By “societal,” I mean that there is an expectation in our society that employees will be covered by in a 401(k) plan and will, if they embrace their plans, accumulate adequate retirement benefits.
If those legal and societal expectations are to be met, plan sponsors need to take charge of their plans and run them like businesses. In other words, they need to have budgets and measure whether budget-to-actual is being realized.
Let me explain. The most common metrics for measuring plan success are participation, deferral rates and participant investing. There should be a “budget” for each of those, and the budget should be compared to actual results.
But, that begs the question, what should the budget be? There are answers . . . good answers.
As a starting point, plan committees should look at data about plans in their industry, and then compare that data to their plan. For example, if the company manages hotels, industry-wide participation may be around 50% of the eligible employees. For law firms, it might be around 90%. The industry data gives committees their “budgets.”
- Deferral rates:
Committees should use the same approach for measuring deferral rates. There is data on average deferral rates by industry. Committees should obtain that data and use it as a starting point for budget-to-actual for the plan.
- Participant Investing:
This is a little more complicated. While participation and deferral rates are easy to define and quantify, it’s harder to define and measure the quality of participant investing. One approach would be to say that target date funds and managed accounts are the yardstick. Another approach would be to add balanced funds and asset allocation models to the mix. For our purposes, either of those definitions will do . . . so long as we acknowledge that it’s an approximation. Committees should get benchmarking “budget” information on investing and compare it to “actual” results for their plans.
Using averages for a particular industry is a good starting point. But, plan sponsors and fiduciaries can do more than that. I’ll talk about that in a future article.
For the moment, though, let’s ask: What should be done when the industry-wide “budgets” for participation, deferral rates and investing are better than the “actuals” for a plan? My recommendation is that the plan sponsor should ask its advisor and recordkeeper for advice. There are solutions for almost every 401(k) problem, and plan sponsors should expect their advisors and recordkeepers to help identify and evaluate those solutions.
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The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.