Northern Trust Recommends Pairing Automatic Enrollment With Escalation

Looking at improvements to retirement plans in the decade since the passing of the Pension Protection Act (PPA), Northern Trust Asset Management says they have been strengthened—but that people are still falling far short of being adequately prepared for retirement.

The firm interviewed 1,000 defined contribution (DC) plan participants and 100 DC plan sponsors, along with a diverse range of industry experts, and has come up with three ways retirement plans could be better positioned.

First, Northern Trust notes, while 52% of sponsors automatically enroll new hires, only 32% pair that with automatic escalation. Sixty-three percent of participants think they could afford to contribute 10% or more of their salaries to their 401(k) plan, but the same percentage said their plan’s deferral rate is below 10%.

“The benefit of using both auto features in tandem is clear,” says Gaobo Pang, head of investor analytics for retirement solutions, at Northern Trust Asset Management. “Among plan sponsors using auto enrollment and/or auto escalation, 64% think that participants using these features are better prepared for retirement. We believe it is time for plan sponsors to strongly consider the potential positive impact of adding auto escalation to their plans.”

Second, Northern Trust urges sponsors and advisers to consider various types of risk that participants face—not just market volatility risk. Fifty-three percent of participants and 46% of sponsors cited market risk as a key concern—but they also mention a variety of other risks, such as inflation, longevity and concentration risk. To mitigate these risks, the firm recommends that sponsors use target-date funds (TDFs) that consider all of these factors.

“Risks evolve over time, so it is crucial that plan sponsors select a default investment option that can help plan participants appropriately deal with a variety of risks,” says Susan Czochara, managing director of retirement solutions at Northern Trust Asset Management. “By constructing a robust default optin, such as a target-date fund that adjusts in line with investment goals, sponsors can help participants manage risk exposures.”

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Thirdly, Northern Trust learned from its participant survey that 84% are concerned about outliving their resources. Eighty-four percent of sponsors, as well, said that longevity risk is a serious problem for their participants. Eighty-six percent of sponsors and 87% of participants think their plan should include retirement income options specifically designed for retirees.

“Although default options work well for most participants during the accumulation phase, people’s needs, circumstances and priorities tend to be very different when they retire,” Czochara says. “In designing a menu of options, plan sponsors need to consider three primary concerns—efficiency, safety and flexibility—to address a variety of retirement income needs.”

As the white paper notes, “Ten years since the passage of the PPA, one thing is clear: DC plans can achieve more. The ideals at the heart of PPA have only been partially realized. As an industry, we can learn from the PPA’s success and missteps. Plan participants are still not effectively challenged to save. Take a closer look at how your target-date funds can address key risks for your participants. We believe income-focused investment options would offer retired participants a way to help ensure that they don’t outlive their savings. The retirement crisis the PPA sought to address 10 years ago still exists today—but the decade ahead is full of opportunity for improvement.”

The full white paper can be downloaded here.