Insights to Action: How integrated plan design and financial wellness programs can improve retirement outcomes
We explore how new research findings from our collaboration with the Employee Benefit Research Institute can help strengthen plan design and financial wellness programs.
The Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management have joined forces to collaborate on data-driven retirement research. Drawing on an EBRI/Investment Company Institute database of 27 million 401(k) participants and a JPMorgan Chase & Co. database of 22 million consumers, the research examines actual spending and savings behavior to provide the first truly holistic financial view of U.S. households.
Our inaugural report, the first in a series to be published over the coming months and years, focused on retirement savings. Why do some people save more than others, even when they have equivalent income? We find that the bottom 25% of savers put aside about 3% less than the middle 50%. Increased spending is constraining their ability to save more.
What are the implications of our first research findings, and, more specifically, what can employers do to help the low savers become more like middle savers? Simply encouraging greater savings without offering practical support may leave participants feeling helpless. In this article, we’ll discuss a range of plan design features, workplace arrangements and financial wellness programs that employers can use to help their employees spend a little less, save a little more and, over time, make a meaningful difference in their retirement account balances. When these programs reinforce one another, they are much more effective—strengthening household finances and laying the groundwork for more successful retirement outcomes.
There is no question that a small difference in spending and saving can have a significant impact on retirement success, but how big an impact? Quantifying that impact can help participants make informed decisions in their financial planning and remind them of the added power of the employer match. To illustrate, we take a look at our low and middle savers, who both earn an annual $40,000 early in their career and peak at $55,000 around age 40–45. We define retirement success as having enough income to replace 81% of their pre-retirement peak salary. Social Security will cover 52% of peak salary, leaving 29% that needs to come from a participant’s 401(k) savings.1
The likelihood2 of achieving retirement success is 12 times greater if one saves like the middle savers (consistently at around 5%) vs. the low savers (consistently at around 2%). Each incremental 1% in added participant savings, coupled with a 0.5% employer match,3 can result in an additional $70,000 in the 401(k) balance at the point of retirement. Therefore, an incremental 3% in added participant savings (i.e., middle savers vs. low savers), when coupled with a 1.5% employer match, can result in an additional $210,000 in the 401(k) balance at retirement. It’s a significant amount that can make a real difference in a retiree’s lifestyle.
Small differences in spending and saving can have a significant impact on retirement success
Of course, this is a difficult time to think about increasing plan contributions, for employees or employers. Many people, faced with financial hardship, may have no choice but to draw on their retirement savings for their immediate cash needs. But employers can help employees take steps to develop better spending and saving behavior—in good times or bad.
Our research findings give us a better understanding of the range of participant behaviors, enabling us to provide useful guidance to employers and employees. Here are some plan design features, financial wellness and benefits programs, and targeted communications programs to consider:
Set up automatic enrollment and automatic contribution escalation
If you haven’t already, get participants enrolled in the plan through automatic enrollment and set them up to increase their contributions with automatic contribution escalation, either as a default or as an opt-in choice. Automatic enrollment on its own may have the unintended effect of freezing plan participants at inadequate contribution rates. With automatic contribution escalation, participants are initially anchored at a lower level of saving. As their contribution rate escalates (usually along with salary increases) participants tend not to “miss” the additional money going toward their retirement savings. We’d note, too, that even the middle savers in our research (participants saving around 5% a year) are not certain to have a sufficient 401(k) balance to reach their targeted income replacement rate.
Rethink the employer match
Many companies are suspending their 401(k) match in light of COVID-19. When their business outlook stabilizes and improves, stretch matches—requiring a higher employee contribution to get the same employer match—can encourage higher savings rates at no greater cost to the employer. If plan sponsors are budget constrained, they may choose to allocate the match in favor of non-highly compensated employees, defined as those earning under $130,000 in 2020. (Discrimination rules prevent plans from discriminating in favor of highly compensated employees).
Financial wellness and benefits programs
Retirement is just one of several important savings goals—one part of a household’s total financial picture. Financial wellness and benefits programs need to address all aspects of that picture. They should include a basic foundation for all other savings and an emergency savings/sidecar account, along with various suggestions to help reduce spending and encourage savings.
Evaluate sidecar savings/after-tax accounts
We anticipate that relief provisions in the CARES Act may result in more withdrawals from retirement savings accounts, given that 401(k) accounts often serve as a household’s emergency reserve fund, which typically aims to cover three to six months of living expenses. Plan sponsors may want to establish a sidecar emergency savings account that employees can use.
Offer transportation savings accounts—and promote their use
Once transportation savings accounts are made available, employers should promote their use. These accounts can help mitigate the effect that higher transportation costs have in crowding out retirement saving.
More flexible work from home arrangements
We don’t yet know what a “new normal” workplace will look like post-COVID-19. Certainly, companies will reassess their operational and real estate needs, and evaluate a wide range of human resources issues. Employers will likely consider trade-offs among issues of corporate culture, safety, cost and productivity. It could be helpful to offer eligible employees greater flexibility to:
- work from home, directly addressing higher spending on transportation
- live in areas with a lower cost of living and thus reduce housing expenses
Targeted communications programs to help educate and reduce spending
Our research finds that low savers generally spend more than middle savers as a percent of salary on housing, transportation and food and beverage. Content that helps participants examine their life choices and understand the trade-offs of spending and saving can help participants make informed decisions that work over both the short and the long term.
- Educate employees about how housing decisions and corresponding transportation costs can directly affect retirement savings. This can be especially useful for millennial and Generation Z employees.
- Encourage employees to actively manage housing costs. These include expenses for heating and internet/cable television.
- Remind participants to regularly review their bills to identify automatic charges that could be eliminated or reduced.
As our research findings highlight, spending and saving are essentially two sides of the same coin. (What we spend we can’t save). Employers can address both issues in their plan design and financial wellness programs—bearing in mind that the programs will be more effective when they are well integrated and mutually reinforcing. The next report in our “Insights to Action” series will focus on the investment implications of our spending and saving research findings.
Digging deeper into our joint research with EBRI, we will see what the data—the first to offer a holistic financial view of a household—tells us about spending and saving patterns. In future reports, we’ll share insights that employers can use to make better-informed decisions and help their employees reach a more successful retirement outcome.
1 The definition of retirement success is based on J.P. Morgan income replacement research. In deriving the income replacement rate, we consider reductions in income tax and expenditures in retirement and assume that Social Security and private savings must together meet the income replacement rate.
2 We determine the likelihood of retirement success based on 10,000 simulations across various market scenarios. Success is defined as the percentage of simulated paths that result in an amount equal to or greater than 81% in income replacement in retirement when combined with Social Security.
3 Our research assumes a 50% employer match up to a 6% employee contribution rate.