Scott Knapp

Employee Retirement Plans: Learn from the Crisis

The financial crisis might be over, but its effects continue to linger.

July 2, 2012

One thing is clear for employers that sponsor retirement plans: The financial crisis and subsequent recession has changed everything.

Traditional thinking about what makes a good retirement plan is being questioned, and plan sponsors are now more keenly aware of their responsibilities to manage their plans with the care, skill, and prudence required by law.

Employers now are more concerned about the fiduciary risks they assume when they offer a plan to their employees. With that new awareness and concern, sponsors are increasingly wondering if their retirement plans are up to snuff.

Investments have risen to the top of the list of concerns held by plan sponsors because they play a large role in the retirement plan arena. Stock markets fell precipitously during the financial crisis, thereby inflicting enormous damage to retirement savings around the world.

Countless savers were forced to either postpone retirement or continue working part-time. The pain continues because many financial markets still haven’t returned to pre-crisis levels.

No doubt, you’re grappling with these challenges if you influence decisions about your credit union’s retirement plan. What should you do?

Here are some thoughts.

Paycheck replacement

When you offered a plan to your employees, you did not enter the investment business. You entered the paycheck replacement business.

Accumulated savings in a retirement plan are expected to be converted to an income stream by employees when their paychecks cease. Given that, enabling adequate income replacement is the most important role investments play, not beating markets or peer investments.

Among the most important plan features you can provide employees is information about whether they’re on time with their savings programs to achieve adequate income replacement at retirement.

This perspective transforms a 401(k) plan into a sort of “individual defined benefit plan” that forecasts liabilities, discounts them to the present value, and then compares existing savings to liabilities.

If there is a savings shortfall, employees have four remedies at their disposal:
1. Postpone retirement to a later age;
2. Plan for less future income;
3. Invest for higher returns, or
4. Save more to close the gap.

Among the four remedies, the decision to save more provides the biggest lift and should be encouraged throughout each employee’s retirement planning lifecycle. Some investments are better than others at facilitating good decisions about saving.

Investments that are broadly diversified, such as balanced funds or target-date funds, can support positive decisions better than their less-diversified counterparts. Investments that are typically less volatile can also help employees stick to their savings plans when markets are under pressure.

Such conservative investments often disappoint during raging bull markets, but sacrificing some investment return in exchange for good employee decisions is a good trade.

Conversely, complex or risky investments can cause employees to become paralyzed by fear or uncertainty, thereby reducing their propensity to save. As such, investments that confuse or scare employees should be avoided.

Too often retirement plan investment lineups are designed to meet the needs of a sophisticated minority of employees under the belief the plan’s complex investments will simply be avoided by those who don’t understand them.

Unfortunately, such complex investments can lead employees who are eligible to participate in a retirement plan to avoid saving entirely.

The financial crisis might be over, but its effects continue to linger. Building a retirement plan investment program that considers the lessons we’ve learned since the crisis is especially important as employees look to their employers for help.

SCOTT KNAPP is CUNA Mutual Group’s director of investment strategy. Contact him at 608-665-8486.