Improving Retirement Plan Participant Decisions: Common Mistakes You Should Seek to Prevent

By Todd Kading, CFP®,ChFC®, Managing Director of LeafHouse Financial Advisors.

As a retirement plan sponsor and fiduciary, part of your responsibility is to help your participants make better choices when it comes to their plan investments. Before we talk about exactly how to help participants make better choices, I'd like to go into why you should be doing so, and what type of benefits you can expect. Here are four points:

Making a dent in the retirement crisis -- The primary reason is to help employees provide for a comfortable retirement. A very large number of Americans are not prepared for retirement. The shift from companies providing traditional pensions to 401ks and 403(b)s, has created a need for much more responsible retirement planning.
Keeping you out of regulator crosshairs -- By having a clear and well documented decision making process for how you designed your plan, you demonstrate that you are doing everything in your capacity to fulfill your fiduciary responsibilities. A retirement plan fiduciary is obligated to act in the sole interest of participants. Procedures intended to improve participants outcomes demonstrate to the DOL that you're doing your job.
Staving off the lawsuits -- Working to prevent participants from making costly mistakes in their retirement accounts can pay off if it stops a potential lawsuit. Although many people had their retirement savings decimated by the 2008 crash, much of this could have been prevented if they were investing in a prudent manner. A little effort goes a long way in preventing the proverbial finger from being pointed at you.
Help yourself by helping others -- Structuring your plan to improve participants' outcomes can benefit you personally. Chances are that you are a plan participant. Providing appropriate plan design and oversight can not only help all participants but also your own account.

Those were some of the benefits of preventing participant mistakes. Now let's list some of the most common mistakes you should seek to prevent.

Not saving enough -- Perhaps the biggest mistake when contributing to a retirement plan is simply not putting in enough money. The other problem is simply not contributing at all. According to the 2014 PLANSPONSOR Participant Survey, a dismal 29% of Americans have saved less than $25,000 in their retirement accounts. It doesn't matter if you get excellent returns if you don't have any principal.

Possible solution -- One of the most effective measures to increase participation in a plan is an auto-enrollment feature. This would automatically enroll new employees to contribute at their hire date. Another solution to the not saving enough issue is to add an auto-escalation feature to the plan. This allows the participants too effortlessly and slowly ratchet up their savings.

Not tax diversifying -- Most people invest all of their money on a tax-deferred basis, refusing to make Roth contributions. Those with lower incomes pay no or close to no federal income taxes. Deferring very little tax now is not as wise as paying the very small amount now to guarantee no tax on the growth later. Also, very high income earners might benefit in adding some money to the Roth 401k because they likely do not qualify to do so in an IRA.

Possible solution -- If your plan does not offer a Roth feature, consider adding that. Then make sure that your participants receive appropriate education around how the Roth works and why they might benefit from adding money to it.

Investing bedlam -- Many retirement plan participants have improper asset allocation. Some think diversification is contributing an equal amount to each fund offered. Some simply pick the highest performing funds from last quarter, year, 3 year, etc. Many also have no idea what their actual risk tolerance and return needs actually are. For 401k participants nearing retirement, the Employee Benefit Research Institute found that about 38% of these investors had 80% or more in equities. This could be disastrous during a bear market like 2008. Participants also tend to exhibit irrational and detrimental trading behavior. Panicked selling during market downturns, chasing returns in last year's hot mutual fund, and attempts at market timing tend to be hazardous to portfolio returns.

Possible solution -- Providing participants access to professional help can be a great way to prevent investment mistakes. A recent Aon Hewitt study showed an investment performance gap between Helped and Non-helped participants of 2.92%, net of fees. Having a third party fiduciary or a managed account option can let participants offload decisions that they know they're not qualified to make. In a similar vein, access to quality "easy button" options such as asset allocation funds, target-date funds, or model portfolios, provides participants without significant investment expertise a way to construct an entire portfolio. When combined with robust education about how these investments work, and how to properly use them, you can go a long way towards averting inappropriate asset allocations.

Using the 401k as a credit card -- Some folks tap into their retirement account to meet monthly cash flow needs. This can destroy their future retirement. Not only are there interest charges and fees involved in borrowing from a retirement plan, but also potentially negative tax consequences. A retirement fund is not an ATM and it's important that your participants understand that.

Possible solution -- Consider the possibility of not allowing loans in the plan. At the very least, limit the number of loans that participants can take out in a specified period of time. Remember that they always have access to the money if they fit into the "hardship" distribution standard. Another idea to help with this is to provide education on the need for adequate cash reserves. Education and access to professional advice could be a big difference here.

Being a plan fiduciary is a tough job with a lot of responsibility and legal liability. But by following plan design best practices, you can help your employees secure a better future and give yourself and the company some benefit along the way.

This article is for general informational purposes and should not be considered tax or legal advice. Employers should always consult with their tax or legal advisors for the application of the ERISA rules to their specific situation.

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