The Fallacy of the Participant Outcomes Mantra

I read about them virtually every day. One fund manager/defined contribution recordkeeper (vendor for purposes of the rest of this post) or another is concerned about participant outcomes. In other words, the reason that a plan sponsor should choose that particular company is because if they do, employees of that company will be prepared to retire someday.

Balderdash! Fiddlesticks!

Almost all of those vendors are preaching the same things:

• Automatic enrollment
• Automatic escalation
• Target date funds
• Retirement education

These are all great concepts, but they are not actually preparing people for retirement. Let's consider Abigail Assistant who works for Zipper Zoomers. Abby just recently started with ZZ. ZZ has hired Abby with cash compensation of $30,000 per year, based on an hourly rate of about $14.50 per hour. When she interviewed, she asked ZZ if they had medical benefits and a 401 plan (yes, she left off the "k" part). When she learned that they do, she didn't ask about details.

It turns out that ZZ does provide health benefits, but they don't pay as large a percentage of the cost as many other companies do, and their plan is a high-deductible plan. Abby and her husband Anson had already decided that 2016 would be a good year for the Assistant family to have their first child and a quick scan of her Facebook page shows that she will, in fact, be delivering Archibald Assistant later on this year. We also learn from her Facebook page that she plans to take 6 weeks off and then put dear little Archie in daycare.

Abby and Anson are going to have really high health care costs in 2016. But, when she started with ZZ, she got all this paperwork and didn't know what to do with it. She accepted her auto-enrollment at 3% of pay ($900 if she didn't take maternity leave). She also accepted her auto-escalation that will kick her up to a 4%  deferral next year. With ZZ's 2% budget for pay raises, her 2017 pay is expected to be $30,600 resulting a deferral of $1224. So her take home pay reflecting only the deductions for the 401(k) plan has only increased by $276 (600 minus 324) or less than 1%. But Abby and Anson's expenses have gone up far more than that. How will they cope?

Always resourceful, Abby and Anson have the answers. They have credit cards with hefty credit limits. That's a source of funds to pay the bills with. And, they learned that they can borrow against Abby's 401(k) account.

Okay, you all know where this is headed. The Assistants are not on the right track and unless they can get off of it, they will never be prepared for retirement. But, how does this make their vendor wrong?

Auto-enrollment and auto-escalation work for those who can afford it. It doesn't work for those who are living day to day, and sadly today, that seems to be the majority of American families.

In the Pension Protection Act of 2006, Congress claims to have intended to protected pensions. They did take some very positive steps while they were at it though by statutorily legalizing what are known as hybrid plans (cash balance, pension equity, variable annuity, etc.) and while they were at it, statutorily legalizing market return hybrid plans.

If you really want to help to prepare your employees for retirement, these are better vehicles. With modern designs and investment strategies, you can control costs. In fact, you can budget your costs better than you can in a 401(k) plan where the amount of matching contributions that you have to make is dependent on the amount that employees choose to defer.

I've seen all the illustrations and projections. Yes, Polly and Peter Professional who both came out of college and got higher paying jobs and who don't plan to have kids until they have been in the workforce for 10 or more years, bought a house and saved both inside and outside their 401(k) plans will be well-prepared, but for all the Abby and Anson's of the world, the participant outcomes will defy what the vendors are saying.

It's not pretty.