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How Do You Measure The Success Of Your Company's 401(k) Plan?

| November 01, 2015
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401(k), 401k, Retirement Plan

The success of the 401(k) plan is important for small businesses. Plan sponsors have been encouraged – especially in the last few years – to understand their fiduciary responsibilities and plan costs. While this is important, does reviewing those things alone mean your plan is a success?

A retirement plan is not just a list of investments. In today’s world, with traditional pensions vanishing, it is the primary tool to help employees replace their income, encouraging them to exit the workforce in a timely (and comfortable) manner.

But how do you know whether it’s working? Do you track percentage participation and deferral rates? Monitor investment performance? Or are there other factors?

All of these are good things to track, but if we are being honest, the single most important thing to measure is this: Have employees gotten to the point where they can successfully replace their paycheck when it comes time?

And there’s the rub: It is notoriously hard to measure that kind of success.

Why? You can only know whether someone has “successfully” retired well into retirement! If the retiree is meeting his or her income needs year over year, retirement was successful. But that tells you only what happened after the fact. You can’t peer into a crystal ball to look 20 or 30 years ahead to lay out the perfect plan.

Tools for Measuring Your 401(k) 

So what can a 401(k) sponsor do today? Barring amazing leaps in crystal-ball technology, the only thing you can do is improve the tools you are using and providing – and review those tools on a regular basis. For example:

1. Monitor your income replacement ratio. This is the purest indicator of employee retirement readiness and is a tool provided by many 401(k) providers. Take the current 401(k) balance (and possibly outside assets) and make assumptions for future deferrals, investment performance, and withdrawal rates. This generates a hypothetical retirement income amount, which, when compared with current salary, gives you the income replacement ratio.

2. Track percentage participation and deferral rates. Participation and deferral rates are very useful but should not just be used passively. Use them to test different programs for educating and motivating employees to participate. Successful programs should see a steady rise in participation as employees understand the need to save more. Tools such as automatic enrollment and automatic deferral increases are popular hands-free methods that boost participation.

3. Select and monitor investment options. Of course you need to monitor investments against benchmarks and industry peers. But also think about asset allocation over time. Aggressive growth makes sense for younger employees, but older employees typically have a higher fear of loss. What options do you have in place to either keep a consistent risk level or automatically reduce it over time?

Again, these make sense only against a background of regularly revisiting your plan. You cannot look at a few numbers and say, “Yup, this plan is successful!” A company can make a decision to keep, modify or move plans only if it is actively monitoring the entire landscape – preferably with a professional as a guide.

Read the article on Small Business Monthly here

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