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March Top Advisor by Participant Outcomes (TAPO)

It’s all about the outcome

What can we do as an industry to improve 401k participant outcomes?

We have tried to drive better participant outcomes through education, with some success. We have also tried to use behavioral finance, again with some success. However, we can now drive improved outcomes at the plan design level with incredible success, and here’s how.

Step No.1

Show the plan sponsor how “on track” their participants are in realizing a comfortable retirement. Improving retirement readiness makes good business sense for employers, since reducing financial stress has shown to increase productivity.

We begin by calculating a retirement readiness ratio based on the popular and widely-available Aon Consulting’s Replacement Ratio Study. This is a gap analysis view rolled-up to the plan level, and includes Social Security calculations.

However, it’s the very definition of traditional gap analysis. While it provides a base, it doesn’t show how the funding gap is filled or, importantly, the impact of the amount of time a participant has with which to fill their gap.

Simply put, it doesn’t recognize or distinguish between one participant that may have 40 years to close a retirement funding gap, and another participant with only has four years, and the risks associated with each. While this is where many advisors stop, it’s where we start.

Step No. 2

Step two sharpens the focus on how effective participants are in the funding of their expected retirement income needs. It recognizes the fact that an effective retirement funding strategy is a combination of savings and investment returns, and the more a participant depends on investment returns the greater the risk they have of failing to achieve a comfortable retirement. We have literally seen participants less than a decade from retirement expecting 20 percent to 30 percent investment returns in order to fill their retirement funding gap. It’s as unrealistic as it is sad.

We next calculate the annualized required rate of return a participant would need (MR3) to fully fund their retirement income needs, assuming no changes in their saving habits. Note that we are not estimating the “impossible-to-know” future returns, rather we are instead projecting the return needed to fully fund retirement knowing their financial goals and savings rates. The higher the returns needed, the higher the risk of not meeting their goal.

We then roll these calculations up to the plan level to provide a more accurate view of the plan’s overall health, which includes the aforementioned consideration of the amount of time a participant has to meet their retirement funding needs. It almost always reveals a less optimistic view than that of the traditional gap analysis.

Step No. 3

Lastly, we show the sponsor on a single page illustration, called a Plan Design Optimization report, which explains how small changes to their current plan design can improve their participant’s ability to comfortably retire. A side-by-side view of their current plan design compared with an optimized plan design, makes it easy to see how auto-enrollment, auto-escalation and other “nudges” can benefit participants.

Two objections are often immediately raised by employers. The first is what they perceive to be a higher cost associated with optimizing the plan. The second is that their participation rates might already be high, so why mess with them (and potentially incur the unnecessary cost)?

These objections are easily overcome. While their participation rate might be high, that is in no way a reflection of how well their participants are doing in reaching their retirement funding goals. And the cost of optimization is often less than their current costs, since contributions are optimized over a greater deferral range.

This report also graphically illustrates how the optimized option improves their participant outcomes both through increase participant balances, reduction of the retirement readiness ratio gap and a reduction of retirement risk (MR3). It encourages plan sponsors to act in the best interest of their participants and documents their fiduciary process, and provides a view of alternative plan designs (think safe-harbor) so plan sponsors can make truly informed decisions.

It is critically important to note that our job as advisors in not to increase participation rates, as coverage does not equal success. It is to improve participant outcomes. Make that your focus, and the rest will fall into place.


Dorann Cafaro, AIF, PRP is senior advisor and founder of New York-based Cafaro Greenleaf. With more than 30 years of retirement plan experience, Dorann is recognized for her unique and unbiased consulting advice and her genuine care for the financial well-­being of retirement plan sponsors and plan participants. She is among the founders of National Retirement Partners (NRP), a leading national network of independent retirement experts, and the Institutional Retirement Income Council (IRIC), whose mission is to facilitate the overall shift in focus of retirement plans. She can be reached at dcafaro@cafarogreenleaf.com.

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