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401(k)

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automatic enrollment

automatic escalation

behavioral finance

default investing

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plan design

Related Resources:

Using Behavioral Finance to Drive Retirement Outcomes, Part 4

Using Behavioral Finance to Drive Retirement Outcomes, Part 3

Using Behavioral Finance to Drive Retirement Outcomes, Part 2

The Evidence Behind The Argument For Passive Management

Are Your Target Date Funds Missing The Mark?

Using Behavioral Finance to Drive Retirement Outcomes, Part 1

Joshua P. Itzoe, CFP®, AIF®

Did you know there are more than 22,000 women who are diagnosed with ovarian cancer each year and that more than 14,000 women lose their lives to this deadly disease annually? Ovarian cancer ranks fifth in cancer deaths among women the risk of getting ovarian cancer during a woman’s lifetime is about 1 in 78.

I know this because my mom is actually a 40-year survivor of ovarian cancer and she was actually diagnosed extremely early due to my birth. And both being in her late 20’s and this early diagnosis was critical to her treatment, her recovery and ultimately her remission.

You see, the overall five-year survival rate of ovarian cancer is 47%, but this varies widely depending on the extent or stage of cancer and the age of the woman. If the cancer is diagnosed and treated before it has spread outside the ovaries, the five-year survival rate is 92%. If cancer has spread to the surrounding organs or tissue (which is known as regional spread), the five-year survival rate is 73%. If cancer has spread to parts of the body far away from the ovary (known as distant spread), the five-year survival rate is 29%. The overall 10-year survival rate for ovarian cancer is 35%. My mom was incredibly lucky because they caught her cancer early before it spread and became terminal, which is why she’s still with us today.

So what does this have to do with retirement? Well, the fact is that we have an impending retirement savings crisis, much like a cancer diagnosis for people’s financial future, and in the words of former Federal Reserve Chairman Ben Bernanke, “The arithmetic, unfortunately, is quite clear.” If people’s savings behavior doesn’t change, and in many cases, quite significantly, they simply aren’t going to be able to make it. And certainly, there are many people that fall into this category. It’s as though they have retirement cancer that’s terminal and the best we can hope for them is to make life a little more comfortable and tolerable, but it’s definitely terminal.

On the other hand, time is actually the great healer and there are many people who are still in the early stages and there’s time to take aggressive action and a great chance they’ll be able to enjoy a long and healthy financial life in retirement.

In this four-part blog series, we’ll be discussing the types of aggressive treatment that are both necessary and effective at curing retirement cancer.

According to the Employee Benefit Research Institute (EBRI), as part of its 2017 Retirement Confidence Survey, only 18% of workers surveyed were very confident about having enough money for a comfortable retirement and only 42% were somewhat confident. 24% were not too confident and a whopping 16% were not at all confident which means that nearly half of all people surveyed are seriously worried about their retirement chances.

So let’s take a step back for a moment and gain a little perspective in terms of the roles and responsibilities of plan fiduciaries in terms of helping employees retire successfully. Section 404(a) of ERISA outlines the basic duties of a fiduciary. And the very first one sets forth the end game or the goal when it comes to making decisions. The entire purpose is to provide benefits to plan participants and their beneficiaries. That’s the vision. Put another way, as a fiduciary, you should be making decisions that put your participants in the best position to accumulate the most money possible at the lowest reasonable cost. I’ve found that many fiduciaries either have no idea this is the job description or they don’t want to believe it. And that’s important, because if you believe something you typically align your decisions and your actions with those beliefs. I think understanding the true nature of the fiduciary calling can actually transform the decision-making process for fiduciaries.

At Greenspring Advisors we are big proponents of plan design features such as automatic enrollment, automatic escalation and default investing. Automatic features have had a tremendous impact on retirement outcomes over the past 10+ years. For instance, in Vanguard’s How America Saves 2018 annual report, the fund company and retirement vendor found the following at year-end 2017:

  • nearly 6 in 10 of all Vanguard participants were solely invested in an automatic investment program (such as a target date fund, managed account or balanced fund), compared with just 1 in 10 at the end of 2003 and this number is projected to increase to 77% by year-end 2022
  • the adoption of automatic enrollment across its client base has tripled since year-end 2007. For instance, 46% of Vanguard plans had adopted automatic enrollment as opposed to just 15% at the end of 2007
  • Aggressive default rates (5%+) have increased substantially. At year-end 2008, only 15% of Vanguard’s clients had a default rate of 5% or more but by year-end 2017 this number had increased to 35%
  • Participant rates at year-end 2017 were 92% were automatic enrollment plans as compared to only 57% for plans where employees had to voluntarily enroll

We think a good starting point for employers is to aim for a minimum of 90% plan participation, at least 10% in total annual retirement contributions per employee and at least 90% of employees should be invested in a professionally managed in a vehicle such as a target date fund or managed account. The key here is that these percentages should be the floor and not the ceiling. Taking steps to address these three areas is probably the single most impactful thing any employee can do for its employees and their financial future.

This is more commonly known as the “90-10-90” formula as outlined by Dr. Shlomo Benartzi shared in his book Save More Tomorrow. Dr. Benartzi is a behavioral economist and currently a professor and co-founder of the Behavioral Decision-Making Group at UCLA Anderson School of Management. His research, conducted with Dr. Richard Thaler of the University of Chicago (and 2017 recipient of the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics), was instrumental in the adoption of automatic plan features which were incorporated into the Pension Protection Act of 2006.

In Part 2 of this series, I’ll discuss some of the behavioral and psychological barriers to saving as well as an honest conversation about retirement income replacements rates.

If you want to learn more about how Greenspring Advisors can get your plan on the path to success, let’s start a conversation.