HOW DOES YOUR 401(k) PLAN STACK UP?
Is it ‘good’, ‘average,’ or ‘bad’? What does it mean for a company to offer a ‘good’ plan? One way to find answers is to benchmark your plan.
The value of a good benchmarking study lies in making comparisons with an established standard. It may be thought of as a “report card” identifying good and bad performers relative to a set of benchmarks, as well as identifying factors that contribute to performance differences.
The idea behind benchmarking a 401(k) plan is simple. By using objective criteria to measure a plan, you gage your plan’s relative strengths and weaknesses. You then have a powerful tool with which to make informed decisions about improving the plan in areas such as plan design, investments, costs, education and communication strategies, and finally, service provider competitiveness.
The Essence of A Good Plan
To determine if you have a “good” plan, to know whether your plan is “successful,” you must ask the following basic questions and then compare the answers to objective data:
- Is the plan in compliance?
- What is the overall participation rate?
- What is the overall savings rate?
- How well have the investments performed?
- Is the plan cost- and operationally efficient?
In general, the more closely the plan is administered according to the terms of the plan document, the greater the number of employees who will participate in it, the more money they will put into it, the easier it is to run and the less costly it is, the more successful the plan. Let’s look at each of these points in more detail.
- Compliance – A successful 401(k) plan is first and foremost in achieving compliance. Meaning, it is administered exactly as the plan document is written. It completes all necessary testing and government filings and distributes all legally required information to participants.
- Participation – This is the litmus test for a successful 401(k) plan. If nobody is in the plan, it’s not working. Average participation rates vary by industry and wage levels. White-collar industries, for example, tend to have higher participation rates than blue-collar and service industries like retail, hospitality, and health care. The overall participation rate across industries is about 75 percent.
- Deferral Percentage -The more money a person puts aside in his 401(k), the greater his chance for a secure retirement. Also, the higher the savings’ rate, the easier it is to pass discrimination testing. The overall average employee deferral percentage is somewhere between six to eight percent.
- Asset Allocation – A 401(k) is fundamentally a long-term savings and retirement plan. The difference between a 6-, 8-, and 10-percent rate of return over a twenty-, thirty- and forty-year time period can be enormous. Asset allocation, or the relative percentage a participant puts into investment options, bonds or stock, is the fundamental investment decision and can have a huge impact on the funds available at retirement.
- Investment Performance – How well (or poorly) the investment options perform, in both absolute and relative terms, has an obvious impact on participants’ account balances. For example, at any given point in time, certain asset classes perform better or worse than others, but that doesn’t mean the investments have performed well or poorly. You need to know how well investments have performed against other similar funds on a risk-adjusted basis as well. Cost is another essential ingredient of the investment equation, with lower-cost funds draining away less from participants’ accounts. Again, this requires benchmarking and ongoing monitoring.
- Cost and Administrative Efficiency – As you are most likely a plan fiduciary, one of your primary responsibilities is determining the “reasonableness” of fees. This presupposes two things: first, that you understand your plan’s total cost structure and second, that you can put these costs into some kind of context of “high,” “low,” or “average.” You can pay a lot and get a little or you can pay a modest amount and get a lot. The reality is that 401(k)s are primarily participants’ money, and since the participants shoulder the majority of plan costs, your primary duty is to keep costs in line. For that you need to know what the total costs are.
Finally, the plan should be run as administratively efficient as possible. Ideally, the plan participant should be able to communicate directly with the service provider for all routine interactions such as questions about the plan, initiating loans, changing investment options, etc. You should also be able to expect accurate record-keeping, competent administration, and real-time access to aggregate plan data.
