Attending the annual conference for ASPPA (American Society of Pension Professionals and Actuaries) gave us a peek into the world of administering retirement plans and the challenges faced by both participants and professionals in the field.
One of the key takeaways from the conference was the surprising prevalence of legacy practices among Third-Party Administrators (TPAs) and the concerning trend of early withdrawals from 401(k) accounts. However, there did not appear to be a great appetite from the industry to proactively tackle the upticks in distributions from the retirement accounts. We took a deeper dive to understand why.
Retirement savings TPAs’ legacy business focus
The 401(k) was originally designed as a long-term savings vehicle to provide financial security in retirement. However, over time, it has increasingly become a source of frequent loans and withdrawals for plan participants in the short-term. When it is the only source of accumulated savings for workers, it becomes vulnerable when they face financial shocks. Seeing employees treat retirement accounts as emergency savings accounts is a concerning deviation from their original purpose, but points to a greater immediate need within the workforce.
As a participant in a retirement account, one would hope that all parties involved in the retirement planning process are motivated to help individuals accumulate the most assets possible. However, a disturbing truth has emerged from the conference: some stakeholders in the financial industry profit from the frequent distribution of retirement funds via distribution fees. This has led to a situation where some professionals are not motivated to reduce 401(k) early loans and hardship withdrawals.
Scott Pooch, President of Integrated Retirement Solutions, says “leakage from 401(k)s and other defined contribution plans is nothing new. It’s been happening at a pretty consistent level for over two decades. But the Retirement Plan industry has been able to (best case) ignore it or (worst case) profit from it by way of fees charged for loans and withdrawals.”
The distribution transaction fees can be substantial – from $50 to $200 per loan, and could become a perverse incentive for administrators.
A staggering 37% of plan participants tapped into their retirement savings early. This trend is a direct consequence of the fact that 57% of American workers do not have enough financial stability to withstand a $1,000 unexpected financial shock. It is a clear indication of the urgent need workers have for an accessible, liquid resource for funds.
How retirement TPAs are becoming agents of positive change
Despite these legacy challenges, many at the ASPPA conference sought a positive change for the retirement industry, including plan participants and sponsors. The attending professionals understood that financial wellness can help demonstrate to plan sponsors that their holistic services include strategies to reduce early withdrawals, realize a healthier retirement savings program, and improve overall financial resilience in the workforce.
One specific promising solution discussed at the conference is the establishment of Emergency Savings Accounts (ESAs). Studies show that individuals with just $1,000 in emergency savings are half as likely to tap into their 401(k) accounts in times of financial stress. By introducing ESAs, retirement account assets can grow undisturbed, as these accounts serve as a first line of defense during financial emergencies.
Pooch adds “Financial Advisors often give lip-service to accumulating an emergency fund. But the most successful formula across entire employee groups to help employees build up emergency savings is by having a specific account, often at a financial institution separate from their other bank accounts, funded by payroll deductions.”
Rather than viewing ESAs as competition or an additional cost, the industry is starting to embrace them as valuable partners in creating healthier retirement outcomes.
Symbiotic relationship between emergency savings accounts (ESAs) and retirement savings
Some have been skeptical about the introduction of Emergency Savings Accounts, assuming they would cannibalize the 401(k). However, data from the early adopters here have shown the exact opposite to be true. Delta, for example, saw an increase in retirement participation after the introduction of their ESA and ESA participants were twice as likely to increase their retirement contributions.
When the 401(k) is not the only savings option, it becomes a more attractive savings option. Emergency savings and retirement savings truly are two symbiotic sides of the same coin.
Another concern often aired from plan sponsors is the assumption that employees can or should build an emergency fund on their own. But we know that is not the case. Nearly 3 in 10 US adults have no emergency savings. Retirement savings has shown us that if workers are not saving for retirement through their paycheck, they are unlikely to be savings effectively or consistently on their own. The same holds true for emergency savings. This gives employers an opportunity to enable payroll deducted emergency savings to automate saving behavior in a short-term savings vehicle, just like they do for their long-term savings vehicle.
Integrating ESAs into the retirement planning process opens new opportunities for collaboration and revenue generation within the industry. TPAs can create awareness of solutions, like Sunny Day Fund, that specialize in providing workplace emergency savings account programs. “The more we support and strengthen participants’ positive saving habits early on, the more we are supporting and strengthening the long-term savings and retirement outcomes ahead” says Ian Koteles, from Dietrich Annuity.
A Brighter Future for Retirement Plan Administration
TPAs can work together to create an improved retirement landscape driven by better plan participant financial wellness. For example, instead of a TPA charging a fee of $100 per loan, they could increase awareness of ESA and financial wellness solution providers that in turn improve the health of their retirement plan, thereby creating a differentiated approach to a commoditized market and retaining business more sustainably.
Employers want to build growth-capable organizations, and partners that help them achieve that stand apart. Fewer 401(k) loans also means more financially healthy workers, putting the employer in a position of growth and success.
Retirement savings issues that lead to attrition have also been seen on the hardship withdrawal side when employees don’t qualify for a withdrawal. In their financial desperation, the employee feels forced to leave the company just to gain access to their savings, or for a lateral move for a modest hike. Having emergency savings mitigates these situations by giving people access to their liquid savings reservoir, making them less tempted by their retirement assets.
We know workers will never be able to build the skyscraper of retirement savings if they lack a solid foundation of emergency savings. Without it, workers continue to raid their retirement plan in times of emergencies, but there is finally a strategic alternative to that. The time is now for the retirement industry to embrace ESAs as partners, providing financial security and peace of mind for participants. By doing so, the retirement industry can adapt to these changing times and improve the financial well-being of millions of working Americans.