Making the Case for Strategically Increasing Your 401(k) Expenses
As you gear up for your 2018 budget process, one of the major line items on the watch list for most companies will be retirement expenses. Companies routinely spend 25% or more of their total benefits expense each year on the costs of providing retirement benefits. And thanks to recent articles in the Washington Post and Wall Street Journal, many readers may be left with the impression that they’ll have to boost up their 401(k) matching percentages to stay competitive.
There’s more to the story though and you should have more insights on what’s happening in the market so you can plan accordingly.
Retirement Benefit Cost Drivers
We have tapped into the Aon Hewitt Benefit SpecSelect™ database to analyze benefit plan designs from over 1,000 organizations. Using this information, we are able to provide competitive insights on the key retirement benefit cost drivers. Outside of the investment and administration expenses, the major categories we see when assessing retirement benefit expenses are:
- Plan Types Offered (Defined Benefit vs. Defined Contribution)
- Eligibility and Vesting
- Employer Matching or Non-Elective Contributions
There is little evidence to suggest employers are making broad sweeping changes across any of those categories. On the contrary, after a decade or so of cutbacks in benefits (freezing pension plans, suspending 401(k) matches, changing formulas to reduce benefits, etc.), we are now in a relatively calm state in the retirement world. The slash and burn days have been replaced by modest plan changes that are more strategic.
401(k) Employer Matching Formulas Staying Flat
Don’t be fooled by headlines that suggest employers are changing their matching formulas. Sure, there are some companies that are making adjustments, but according to our data from Benefit SpecSelect, the maximum employer matching contribution to 401(k) plans is averaging about 4.3% of pay, and this hasn’t changed materially over the past few years.
Ninety-five percent (95%) of participants in our database reported having the same matching formula in 2017 as they did in 2016. Of the 5% of participants that did make a change, just over half of them increased their company matching percentage while the others actually reduced their obligation for 2017.
Increases Driven by Higher Employee Participation
We do see some companies having to spend more on their 401(k) retirement plans because employees are saving more -- leading to increased matching contributions. The most common reasons for higher employee participation stem from strategic modifications companies have been making to their plan designs. For example, companies that have implemented automatic enrollment and automatic escalation are seeing increased costs due to higher participation rates and matching costs.
The prevalence of both of these features has increased steadily since the passage of the Pension Protection Act of 2006. However, in recent years we have seen more organizations increasing the savings rate at which they default their employees into the plan, as well as increasing the limit to which they will continue to increase the employee savings rate each year after the initial enrollment.
For example, just five years ago, 60% of companies reported using an automatic enrollment feature and two-thirds of those companies had a default savings rate of 3% of pay or less. In 2017, the percentage of companies using automatic enrollment climbed to 66%. Even more significant than that modest growth in prevalence is that the majority (51%) of those plans now use a default rate that is higher than 3%.
We also continue to see steady growth in the prevalance of the use of automatic escalation features. Automatic escalation is used to help employees grow their savings by automatically increasing the contribution percentage.
In addition to the increased prevalence, companies are also finding they can boost employee savings by raising the ceiling on just how high the automatic escalation can grow. Five years ago a rate of 6% was by far the most commonly used ceiling. In 2017, a 10% escalation maximum is the new standard.
Both of those automatic features allow participants to manually adjust their contribution rate or opt out of the plans altogether. Organizations are taking these actions in part to increase both the participation rate as well as the amount employees are saving for their own retirement.
Offsetting the Costs of Higher Participation
Higher plan participation and employees saving greater amounts lead to increased costs employers pay toward the retirement benefits. Sure, there is some relief to the employer as increased 401(k) participation lessens the payroll income tax burden. But we also see some companies making additional plan design modifications that help offset the costs of higher participation. Two of the more common plan modifications are:
- change the contribution frequency (from per pay period contributions to annual contributions)
- increase the amount of employee savings requirement needed to reach employer matching levels (i.e, from $.75 match on 4% of pay to $.50 match on 6% of pay)
Is Your 401(k) Plan Competitive?
While the retirement benefit landscape has been relatively quiet in recent years, you have a lot at stake in making sure you are getting the most value for your benefits dollars. As you start to build your budget recommendations for 2018, you might want to consider a plan design check-up.
Using our Benefit Index® benchmarking tools, we can help you assess your overall plan design and whether auto-enrollment and auto-escalation features are right for your organization. Click here to learn more about Aon Hewitt’s Benefit Index and Benefit SpecSelect.