Building a Better 401(k)
E verybody wants it. Nobody has it. It may not even exist. Not yet, at least. It’s the Perfect 401(k)—a plan in which every worker participates, saves at adequate levels, and invests simply, appropriately and inexpensively along the way to retirement.
The Perfect Plan emphasizes not only saving for retirement but also the process of properly withdrawing from a 401(k), so workers don’t outlive the savings they’ve spent 30 to 40 years accumulating.
It’s a plan that, if done right, is more than just a compelling retirement benefit—it’s a competitive weapon, one that helps lure and retain key talent and serves as an underlying driver of productivity and profitability.
Some companies just don’t get this—and perhaps never will. Yet there are employers teetering on the brink of perfection. At these companies, it’s not just about adding the latest bells and whistles. (Just about any defined-contribution plan sponsor can flip the switch on automatic enrollment, for instance, and increase employee participation rates overnight.) Financial Week has identified companies that have a real plan behind their plans; together, they suggest a blueprint for the Perfect 401(k)—and a glimpse at the future of corporate retirement benefits for everyone.
There will be 100 percent participation—through real financial planning advice for workers
Most benefits officers would view having 83 percent of employees participating in the company’s 401(k) plan as a job well done. But to Annette Grabow, manager of retirement benefits at construction company M.A. Mortenson, it’s troubling.
"It means there are 200 people here who aren’t saving in our plan," says Grabow, who oversees the $107 million 401(k) plan the Minneapolis company offers to its 1,300 employees. "And that just doesn’t work for me."
Grabow wants every employee participating. That’s right: every one of them. As part of a statewide personal finance initiative undertaken by Minnesota’s largest employers, she recently pledged to have 100 percent of her employees contributing to the Mortenson 401(k) by the end of 2009. And even though Mortenson’s employees contribute an admirable average of about 8 percent of their pay to the 401(k), Grabow wants to boost that number too.
Lofty goals, but with the way the company’s 401(k) education programs have worked in the past, Grabow insists, anything is possible. "If I would have set my goal at 99 percent participation, then I would have been OK with settling for 98 percent," she says. "But I couldn’t accept anything less than 100 percent, as aggressive as it may seem."
Mortenson could have chosen to add an automatic enrollment feature and hit Grabow’s goal overnight. But she’d rather educate and encourage employees to opt in, proactively save for retirement and choose their own investments: "Auto-everything is the easy way out. But it doesn’t relieve you of your responsibility to educate."
That means Grabow must always be talking to employees about the 401(k), in a number of formats, but without being intrusive—or worse, forgettable.
There’s the annual benefits road show, for which Grabow and other Mortenson executives organize speakers and workshops to get employees thinking about their financial future. (The company is careful not to use the word "retirement" too much, because it may not resonate well with some of its younger workers.) They talk about the basics, such as why employees can afford to participate in a 401(k) even if they’re inclined to think they can’t. And they talk about saving for retirement in a broader context than 401(k)s. "After all, it’s part of a financial planning process," Grabow notes. "You need to get them to think about creating and living on a budget."
There are other subtle, year-round reminders on Mortenson’s intranet, such as videos of management discussing the benefits of the company’s 401(k). There’s a video game given to new hires that’s aimed at teaching young workers about making the right "life choices," including the need to start saving for their retirement—ahem, the future—at an early age.
Work-site materials, including the inevitable poster campaigns, are reinforced as frequently as once a quarter by postcards and packages sent to employees’ homes. The company drums up new messages and themes at least once a year to keep existing participants engaged, while also attempting to attract the attention of nonparticipants. "It has to be slick," Grabow says. "It’s marketing, make no mistake about it, and there’s a lot of competition for your employees’ attention."
Case in point: Later this year, the company will send customized boxes to the homes of employees who don’t participate in the 401(k). Letters end up in the garbage, Grabow says, but everyone likes a package. Inside, workers will find rubber ducks dressed in construction outfits to remind them "they don’t want to be the odd ducks not in the 401(k) plan."
Goofy? Sure. But whether it’s shtick or slick doesn’t matter when you’re trying to get through to every last employee. "It’s an ongoing process," Grabow says. "You don’t just stop because most of your people participate—it’s a challenge, but you have to keep pushing until you find a way to communicate with everyone."
Most companies should have such problems.
There will be a generous employer match—made in cash, not stock
To hear Frank Rudolph tell it, a retirement plan in the energy industry isn’t just a perfunctory benefit anymore—it has become a necessity. And not just for the employees, but for the companies themselves, which are competing for talent when demand is at an all-time high and qualified candidates are in considerably shorter supply.
"With oil hovering at about $130 a barrel, the pressure is on us to be as productive as possible," says Rudolph, senior vice president of human resources at Devon Energy, an oil and gas firm. "And we’re in need of every engineer and every physicist available right now."
Complicating things further for Devon: It’s also staring at a massive wave of retirements over the next several years, with roughly half its 5,200 workers expected to hang up their spurs during the next decade.
So Devon has decided to use its benefits platform to do battle in the war for talent against the likes of Shell and Chevron. At the forefront of its fight is a 401(k) plan that boasts a company match on steroids, one that’s more than just a perk or a marginally competitive benefit—the size of Devon’s match puts it in a league of its own.
The company matches employees’ contributions dollar for dollar—that’s with actual cash, too, not company stock. The even match is a bit of a rarity in corporate America, as only about 20 percent of employers offer it, according to the Profit Sharing/401(k) Council of America. But Devon’s matching also climbs with a worker’s tenure. For employees with up to five years of service, the company provides a match for 401(k) contributions equal to up to 11 percent of employees’ annual pay. For those with five to nine years, it matches up to 14 percent, and workers with 10 to 14 years get a match of up to 18 percent. Employees who have been with Devon for 15 years or more get a matching contribution of up to 22 percent of annual pay.
To put that in context, the most common match is 50 cents on each dollar up to the first 6 percent of pay, according to the Profit Sharing/401(k) Council.
So at most other companies, a new hire who earns $50,000 a year and contributes 6 percent of that to the 401(k) would be saving $3,000 a year if she maxed out the company’s match—plus $1,500 more coming from the employer, using the typical match.
At Devon, this same worker would be saving $11,000 a year—with $5,500 of that coming from Devon—if she contributed enough to receive the full company match.
"A new hire does consider it part of his or her compensation, too, which also helps from a competitive perspective," Rudolph says. New hires are subject to a vesting schedule of 20 percent a year and become fully vested in Devon’s 401(k) after five years.
"When I’m out at the college campuses recruiting now, many candidates are comparing our offerings to our competitors’ and state how much these benefits actually mean to them," Rudolph says. "They can take a quick pen to it and see the difference right away."
The megamatch wasn’t put in place just to help Devon recruit, however. Last year the company gave its employees the option of sticking with the traditional pension or moving into the super-401(k), which it dubbed Portfolio Two. Like many other companies, Devon was phasing out its traditional pension because it became too costly to maintain and threatened to bring too much volatility to the balance sheet. "Recruiting and retention played a big part," Rudolph says, "but we also wanted to do the right thing for our employees."
The matching program was designed to give those workers who opted for the 401(k) a defined-contribution retirement plan whose value was equal to that of the defined-benefit option. "We spent a lot of time calculating the numbers for these contribution levels," Rudolph says. "We didn’t want to create two tiers of employees."
It’s not surprising that Devon has 87 percent of its workforce participating in the 401(k)—with the bulk of the participants made up of its younger workers. The company may be well on its way to alleviating the generation gap that has shaped its workforce while also adding to its competitiveness in the near term.
There will be easy-to-use target-date funds with rock-bottom fees
Back in 2003—during the pre-Pension Protection Act era in which every 401(k) participant fended for him- or herself—Intel was in the early stages of revamping its 401(k) plan when, suddenly, the proverbial light bulb went on.
"But we started taking a hard look at what we could do to make the plan more attractive to our employees who were still sitting on the sidelines," says Fred Thiele, manager of global retirement benefits at Intel. "Just offering the standard host of fund options, without any particular order to them, left a lot of people feeling fearful of the investment side of things. And that kept a lot of people from opting in."
That’s when Intel elected to build its own set of customized target-date funds—several years before mutual fund companies began flooding the corporate retirement and retail investor market with hundreds of them—to help appeal to those timid employees.
To construct the new "life-stage" offerings, Intel’s retirement team packaged the core funds that were already available to employees, using an asset allocation that was based on a participant’s estimated retirement date. Intel also created a glide path that would reallocate and rebalance participants’ assets over time, as they grew older and approached retirement.
For instance, an employee who will retire around 2045 would start out in an Intel life-stage fund that holds 90 percent equities and 10 percent fixed income. By the time he hits that retirement date, the portfolio is an even split of stocks and bonds.
"We don’t give investment advice for obvious reasons," Thiele says. "But it’s a yardstick, and it’s a way to ‘DB-ize’ the 401(k) plan, so employees have some of the same advantages they would have had with a traditional [defined-benefit] pension."
Perhaps nowhere are these advantages more evident than in the pricing of Intel’s life-stage funds—hardly a passing point, considering that more than a dozen large companies are fighting off lawsuits from 401(k) participants charging that fund fees were excessive.
With $4 billion in its plans, Intel has plenty of leverage when it’s negotiating with fund managers eager to take on a piece of its growing pool of assets. And because Intel isn’t looking to profit off of the life-stage funds, it needn’t charge any packaging fee on top of already-low fees on the underlying institutional funds used to build the life-stage offerings.
Add all of this up, and Intel’s participants are paying 0.06 percent to 0.11 percent of assets a year for one of its life-stage funds—a pittance compared with the average 0.62 percent that 401(k) participants in other companies pay for target-date funds, according to Hewitt Associates.
"You see the power in how much money is going into these funds, so you can work the expense ratios down if you have the scale and resources," Thiele says.
Intel is now halfway toward reaching its participation goal. About 80 percent of its 45,000 U.S. employees are contributing to the 401(k), up from around 70 percent five years ago, but it wants to get that number closer to 90 percent in the near future. The life-stage funds played a big part in luring some of the nonparticipants into the plan, Thiele says, but the funds have also appealed to many employees who already participated but wanted a simpler option than independently managing their investments.
"We’re in an era now where employees are becoming more and more responsible for their own retirements," Thiele says. "So we feel we have to do whatever we can do to get as many people into the plan as possible, and provide them with enough tools so they can get themselves to, and through, retirement without any issues."
There will be a decent annuity option to help retirees cash out wisely
When your company sponsors a $50 billion defined-benefit plan and a $30 billion 401(k), there’s no such thing as a small decision when changes have to be made to retirement benefits.
So when IBM chose to freeze its DB plan to new hires a few years ago and steer them into an expanded 401(k) starting this year—a move that will save the company $3 billion by 2010—it carefully considered every bell and whistle added to the new 401(k). There are the auto-everything features, such as automatic enrollment, automatic company contributions and automatic savings options. Then there are custom target-date funds and free education and financial advice tools that IBM now makes available to its participants, all aimed at getting employees on track to save enough for retirement.
But there’s another significant, although slightly less central, feature in the IBM plan that may soon be getting some play with other large plan sponsors: an IRA annuity option.
Of all the decisions IBM officials made in designing the new 401(k), "adding the annuity was the easy one," says Jesse Greene, vice president of financial management at the technology titan.
Most companies have a tough enough time just getting their employees to think about saving for retirement, so getting them to consider how to properly withdraw funds from their 401(k) accounts can draw a lot of blank stares. But with more than 70 million Americans set to retire over the next decade, the concept of "decumulation" is becoming a much more relevant topic for plan sponsors and participants alike.
"When companies started offering defined-benefit plans in the 1950s, people didn’t live that long," Greene says. "Now longevity is a major issue for employers and employees."
IBM officials believed it was critical to have an annuity option for 401(k) participants to help them preserve their savings all the way through retirement—even if they live into their 80s and 90s, Greene says. "People are losing the DB option, but we felt we needed to provide them with something that offers the same kind of protection against longevity as a traditional pension."
That’s when IBM elected to tap Hueler Investment Services, a Minneapolis firm that takes a different—and low-cost—approach to annuity programs.
While annuities have been part of plan options in 401(k)s for years, they haven’t had much appeal for participants for a number of reasons, says David Wray, president of the Profit Sharing/401(k) Council, adding that only 1 percent of participants annuitize part of their retirement savings through their employers.
One of the barriers has been cost, with annuities carrying fees that can run from 4 percent of assets all the way up to 13 percent in some extreme instances, Wray notes.
There also are hurdles a company must clear just to offer an annuity as a plan option in a 401(k). "The consequences for being noncompliant can carry significant fines," he says, "so much so that a good number of employers have been pulling annuities as plan options."
Hueler’s program offers annuities as an individual retirement account option, however, instead of a traditional plan option, and allows participants to roll over their 401(k) assets into a range of annuities, such as fixed-income or inflation-protected annuities. Because employees acquire the annuities in an IRA, rather than within the 401(k), the program circumvents compliance issues and gives sponsors a headache-free way of providing plan participants with annuities.
Kelli Hueler, president and founder of Hueler Investments, says that although IBM was one of the first companies to tap her firm for this annuity option, more corporate plan sponsors have begun to warm to the idea of adding Hueler’s annuities offering to their 401(k)s to "pensionize" participants’ retirement assets.
"Typically, there hasn’t been a lot of flexibility for participants with the standard annuity options in their plans, and so they haven’t had a lot of success with participants or sponsors," she says.
Hueler’s program allows participants to annuitize as much or as little of their 401(k) assets as they choose. "It’s been an all-or-nothing approach in most cases," she says. "And that’s not a palatable decision for most participants—you’re essentially asking them to make a lifelong decision, at a single point in time, to annuitize their entire portfolio, or nothing at all."
Pricing is another plus for the Hueler program. It offers group rather than retail pricing. It also pits insurers against one another in a competitive bidding process for an annuity contract, another way to ensure a participant isn’t being overcharged. And Hueler doesn’t take a fee from the insurers, which also keeps customers’ costs relatively low. Hueler says her fees generally range from 1 percent to 2 percent of the assets that are being annuitized—a far cry from the 5 percent to 6 percent that typical retail annuities carry.
All of this resonated with IBM, Greene says, because it’s in tune with the company’s modus operandi for offering retirement benefits. "Our philosophy has always been to provide valuable choices that are low-cost," he says, adding that IBM 401(k) participants don’t pay more than 10 basis points for their entire portfolio to be managed. "Fees just eat away at retirement income, and that’s counterintuitive to the whole process."
There will be additional tax breaks on savings through a Roth 401(k)
There aren’t many things a company like Demco—a small supplier of library furniture and equipment in Madison, Wisconsin—has in common with Intel, IBM and General Motors, with their tens of thousands of workers and billions of dollars in retirement assets.
With about 250 employees and roughly $30 million in retirement assets, Demco does, however, boast one of the same best-of-breed benefits that some of the nation’s largest employers have been rolling out to their massive workforces in recent years: a Roth contribution component for its 401(k) plan.
"It’s a different tax play, and you’re giving people a choice about when they pay taxes on a major piece of their future retirement income," says Don Rogers, CFO at Demco. "We thought it was a good option before we added it to the plan a few years ago. Our employees obviously now think that, too."
Almost half of the company’s employees now make Roth contributions to the company’s 401(k), which Demco offers in addition to a profit-sharing plan, Rogers says.
Since the Internal Revenue Service gave the go-ahead for participants to make Roth contributions to 401(k) plans beginning in 2006, the feature has had some real appeal for a number of corporate plan sponsors, like Demco, and continues to gain favor.
In just the past two years, roughly one out of every five corporate plan sponsors has added a Roth option, which allows employees to make after-tax contributions to their 401(k)s. Unlike traditional 401(k) deferrals that workers make using pretax dollars, participants will not be taxed when they withdraw their Roth contributions—as well as the investment returns they’ve earned on these contributions—for their retirement.
The Roth’s proposition is simple: Pay now, have later. And that’s exactly why more and more employers are considering adding a Roth feature to their 401(k)s and why it will probably be a staple in many plans in the not-too-distant future, says Gary Gross, executive director of Grant Thornton’s compensation and benefits practice.
About a quarter of the companies that don’t currently offer the Roth option are considering adding such a feature this year, according to a recent poll by Grant Thornton. An additional 60 percent of plan sponsors said they are contemplating adding a Roth 401(k) at some point in the near future but didn’t offer a specific timetable.
One of the things keeping some employers from offering a Roth option is that it adds to the already long list of decisions that employees have to make about their 401(k) plans and retirement savings, Gross says. "The Roth is a great option, but it may not be right for everyone."
With the Roth, participants are essentially prepaying the taxes on their retirement income and giving up some of the short-term benefits they would get from making pretax contributions to a traditional 401(k), like lowering their annual taxable income. So participants need to consider their current tax position before opting for the Roth, Gross says. For example, Roth contributions might be most appropriate for workers who are currently in a low tax bracket but think they may pay higher taxes in retirement.
"It’s a bet on your tax situation," he says. "And communicating this to your employees can be a real challenge."
But some companies, like Intel, do what they can to help employees make these difficult decisions. "You can’t just offer it without decision-support tools," says the company’s Thiele.
Intel has calculators on its company intranet that allow participants to perform a relatively easy side-by-side comparison of Roth and traditional 401(k) savings.
"They can run the numbers and decide what’s right for them," Thiele says. "It may not be for every employee, but in a comprehensive 401(k) fund the goal is: Leave it up to participants to decide what might be in their best interests."