As the sun was setting on 2017 at the condo in St. Pete…

I was reflecting on “Final Grades” for the year. How did America’s 401(k) plans grade out this season?

Spending Christmas with the family in Florida was great…and warm…but now it’s back to the frigid reality of this arctic blast here at home; the sun and surf were fun, but we knew it was temporary, that it didn’t have staying power…like a glacier. Returning to find our car covered in ice at the airport was a harsh reality, and reality is hard to face, particularly when it comes with a wind chill factor. 

Seems appropriate at this time of year to set some New Year’s Resolutions, but first it would be prudent to take an honest look at final grades for 2017. (The New Year’s Resolutions will be in the next blog post.)

Our consulting firm builds and designs (or fixes and redesigns) employer-sponsored retirement plans and financial wellness programs. We believe that retirement plans should be measured by the simplest of standards: does it bear good fruit? After all, a good tree can no more produce bad fruit than a bad tree can produce good fruit.

How do you identify the plans that work? By their fruit!

By their fruit you will recognize them.

A plan that works produces good retirement outcomes, it’s filled with participants who are retirement ready, and it has a high retirement rate. (Just as schools should be measured by their graduation rate, not their performance on the field or on the court, so a retirement plan should be measured by its retirement rate.)

Simple, right?

Except that this is not the criteria that most businesses use to evaluate their retirement plans. Most 401(k) plans are evaluated or graded on one of two standards: cost or investments, fees or funds.

FEES: If the cost of your company’s 401(k) or 403(b) retirement plan has not been benchmarked recently, it’s probably time to do so. Every plan should be benchmarked every 3-5 years. There has been a ton of fee compression in the industry, so chances are that you might be paying too much.

• But fees are not a measurement of plan success.
• If you’re paying too much, perhaps the retirement plan is failing in that particular area…and if you’re paying less perhaps the retirement plan gets a better “grade” … on FEES … but there is little correlation between fees and successful retirement outcomes.
• The plan might get an A on fees but FAIL the final exam if no one is ready to retire.

FUNDS: If the investments in your company’s 401(k) or 403(b) retirement plan have grown this year … congratulations! That means they were probably invested in the stock market, which just hit 25,000 points, the fastest 1,000-point expansion in the history of the DOW. In fact, if your company’s investments did not grow this year, something is dreadfully wrong. Everyone’s account grew this year. Having poor fund performance would be nearly impossible. A chimp throwing darts at the wall could accidentally hit a winning portfolio in this market. The probability of hitting success in this market is so great, I’d venture to say the only anthropoid that could screw it up would be … the homo sapien (which, ironically, means “wise man.”)

Having fantastic fund performance might mean that the investments in your 401(k) plan receive a passing grade, but it doesn’t always translate into the plan itself receiving superior marks for successful outcomes.

Should the 401(k) and/or 403(b) evaluate the Fees and Funds? Absolutely! But their grade provides a small portion of the overall final grade.    

Final Grades for 2017 (as in every year) should be based upon three criteria:

• Participation Rate
• Savings Rate
• Average Account Balance

Again, the goal is to provide successful retirement outcomes, helping employees retire well and retire on time. No matter how low the fees and how high the fund performance, if too few employees are participating, and/or if they are saving too little, they will not be retirement ready.  

The harsh, bitter, cold reality?

Many retirement plans are failing by this criterion.

The participation rate that receives an ‘A’ is 100% participation. Everyone should be in a 401(k) / 403(b) retirement plan. Grading on the curve, allowing for the one-off, special circumstances of a few non-participating employees, means that 95% is still considered a superior mark. But it’s hard to give a passing grade to a plan that has participation below 90%; it’s hard to imagine that more than 10% of any employee group can’t afford to save at least a few percentage points. And rather than letter grades, this category is probably best understood as a simple Pass-Fail. After all, getting a ‘C’ for retirement preparedness is failing. So, on a pass-fail criterion, any participation rate below 90% would have to be a failing grade.

• The average participation rate in 401(k) plans today is 87%;
• Many plans are below this 87% mark;
• If your retirement plan is failing on participation, it doesn’t matter how well the plan is doing on fees and funds.

The savings rate that receives an ‘A’ is 15%. Everyone should be in aiming to save 15% (or more) in their 401(k) / 403(b) retirement plan. Grading on the curve, allowing for the one-off, special circumstances of a few employees, or allowing for an especially high employer match, means that 10% might be enough to get some employees to retirement. But it’s hard to imagine any employee retiring well if they save less than 10%, and it’s even harder to give any employee a passing grade if they’re contributing less than the employer match.  

For illustration purposes, let’s imagine that the employer match in your retirement plan is 6%. In other words, if you contribute 6%, you receive the full company match.

• Contributing 15% (or more) under those circumstances, is an ‘A’;
• Contributing 10% is a passing grade…just barely;
• But contributing less than 6% is a failing grade (because you miss out on the full match);
• And the average savings rate in 401(k) plans today (according to Vanguard) is stuck at 6% (while 32% of employees fall below 4%);
• If the average savings rate in your plan is less than 10% (and certainly if it’s less than 6%) it is unlikely to produce successful retirement outcomes.

Another way to measure whether a plan is on track to be successful is measuring whether employees will have enough money to retire on time. According to a Vanguard study (as reported in Money Magazine) the average account balance in 401(k) plans dropped in 2016 to approximately $96,000. The nonpartisan Employee Benefits Research Institute is reporting that 2017 rebounded nicely with about a 20% increase for employees within a decade of retirement, and a 43% increase for employees under 35 years of age. That’s fantastic news, right?

The reality is that it’s mixed news, and many retirement plans do not have a passing grade.

• The average 401(k) account balance is now six-figures;
• But $100,000 is hardly enough to retire;
• And many plans have many plan participants with far less than $100,000;
• Divide your total account balance by the number of plan participants (both active as well as termed) and if the average account balance is not safely above $120,000 the plan may be in trouble.

The point is, we’d like to optimistically look towards 2018 with New Year’s Resolutions, but it helps to begin with an honest evaluation of 2017. And that evaluation must extend beyond fees and funds, which have little correlation to determining successful outcomes. That evaluation should center upon average participation rate, average savings rate, and average account balance…and frankly, by those three factors, it is obvious that there is much work to be done.

A surging market can help us get back on track…but only if employees are participating and saving enough in that surging market.