How good is your 401(k) plan?

Now’s a good time to figure out whether you have an excellent 401(k) plan or if it’s lacking.

That’s because the Supreme Court ruled last week in favor of workers who sued their plan sponsor and fiduciaries over selecting high-cost investments for their 401(k) and for not monitoring those investments — even though the six-year statute of limitations had passed.

So how might you tell? What standards might you use? Well, the Defined Contribution Institutional Investment Association (DCIIA) released this week, just by coincidence, a white paper that highlights what defined-contribution plan sponsors and fiduciaries could put in place to help participants save enough for a comfortable retirement.

The paper, Defined Contribution Plan Success Factors Framework for Plans with an Objective of Retirement Income Adequacy, talks about how 401(k) and similar plans should be designed, the type of investments that ought to be used in a plan, and how the plan should be monitored.

Truth be told, the paper is intended for a professional audience, but we think workers could use the report to compare and contrast how their employer-sponsored retirement plan stacks up against DCIIA’s recommendations.

Plan design

The first order of business: Evaluate your plan’s design. According to DCIIA, features such as automatic enrollment and automatic contribution escalation can significantly improve retirement readiness by helping to increase participant enrollment and contribution levels.

The report noted, for instance, that workers are unlikely to enroll in their 401(k) plan if they don’t start saving a part of their salary beginning with the first paycheck. And not saving for retirement certainly won’t help you get ready for retirement.

So, to make sure folks start saving as soon as possible, best-in-class plans automatically enroll workers in their 401(k) plan with a starting deferral rate of 3%, or more in some cases. Research shows, however obvious it might sound, that enrollment at a 6% salary deferral rate can result in improved retirement outcomes.

The other important feature for a 401(k) plan to have would be something called “automatic contribution escalation.” According to DCIIA, fiduciaries ought to consider automatically increasing how much participants contribute to their plans by one to two percentage points a year, and at least two percentage points if the default rate is less than 6%. If your plan has this, consider yourself among the fortunate few.

“Auto enrollment alone, when not combined with automatic contribution escalation, may give participants a false sense that they are saving enough,” wrote the authors of the DCIIA report.

The report also suggests “stretching employer matching contributions.” At the moment, many employers match 50% of the first 6% workers contribute to their 401(k). But DCIIA suggests a better match might be this: 33% on the first 9% of deferrals. That strategy can help motivate participants to reach higher savings rates.

DCIIA also recommends that plans put in place re-enrollment strategies; plans could, for instance, re-enroll workers into default investments or re-enroll workers into higher default deferral rates. “Continued efforts to get nonparticipating employees enrolled, and existing participants appropriately diversified and saving at a robust level, can be the most important actions plan sponsors take to help employees achieve retirement readiness,” wrote the authors of the DCIIA report.

Plan sponsors also ought to discourage early withdrawals and loans from retirement plans. Among other things, DCIIA noted that “leakage in the form of cash-outs at separation of employment can materially reduce the probability of replacing a sufficient level of income in retirement.”

Another novel feature worth having: Plans ought to encourage the consolidation of workers’ various retirement accounts. In other words, 401(k) plans should let workers “roll-in” the balances of their IRAs and their prior employer’s defined contribution plan into their current employer-sponsored retirement plan. “Consolidating eligible retirement accounts into one plan can help participants better manage their assets, gain economies of scale, and plan for retirement,” wrote the authors of the DCIIA report.

Investment structure

It might be not easy to say which plans have the best-in-class investment lineups and structure. But the best likely use one or a combination of features highlighted in DCIIA’s report. What might those features be?

For one, plan fiduciaries should document, perhaps in the form of an investment policy statement, the reasoning behind the strategies selected for the plan’s core investment lineup and its qualified default investment alternatives, or QDIA.

Another feature worth having: professionally managed investment options in the form of managed account, target date and/or balanced options. Why might this be important? “Many participants do not have the knowledge or desire to make investment decisions and may benefit from professional management,” wrote the authors of the DCIIA report.

Having a plan with an “open architecture framework” can be a plus, too. Consider: plan fiduciaries, with this sort of framework, can build an investment lineup that gives plan participants “exposure to diverse investment offerings,” wrote the authors of the DCIIA report. And that’s a good thing. It means that fiduciaries can construct plan investment menus that are consistent with their investment policy statement.

When it comes to investment menu offerings, DCIIA also said less may be more. Not surprisingly, DCIIA suggested that plans offer participants a low number, say 10 or fewer, of core investment options. According to DCIIA, the average plan offers 18 investment options. But that’s not always in the best interest of the plan participant. Research shows, wrote DCIIA, that participants may feel overwhelmed by too many investment choices.

Two important objectives for plan sponsors and fiduciaries are to offer a “comprehensive asset allocation solution that allows participants to alter their asset allocation and risk exposure over time, and to avoid overwhelming participants with too many menu options,” wrote DCIIA.

Plans might also consider offering workers a mix of active and passive investment options. “Instead of selecting an investment lineup that is all actively managed or all passively managed, defined contribution plan fiduciaries may see certain asset classes as efficient, and therefore good indexing candidates, while other asset classes may be better served through active management,” wrote the authors for the DCIIA report.

Plan fiduciaries might also consider excluding or limiting company stock as an investment option in 401(k) plans. Why so? “Significant investment in company stock can pose diversification risk,” wrote the authors of the DCIIA report.

And plan fiduciaries might consider including nonregistered investments, such as collective trust funds and separate accounts. “Collective funds and separate accounts available to defined contribution plans are generally valued daily, offer holdings transparency, and may have a cost advantage (after consideration of both investment and administration fees) over mutual funds,” wrote the authors of the DCIIA report.

Having investment options that produce a reliable monthly income for the so-called “decumulation” phase of a worker’s retirement is a sign of a good 401(k) too. Doing so “signals to plan participants the need to consider income sources postemployment, and extends their planning time horizon beyond the point of retirement,” wrote the authors of the DCIIA report.

Plan monitoring

Plan fiduciaries should also have in place metrics to evaluate the overall success of a 401(k) plan, how well it’s serving the needs of all participants. And that’s even more important, we might add, in the wake of the Supreme Court’s decision in Tibble v. Edison International.

The metrics would include the plan’s “inputs,” such as participation rates, savings rates, investment performance and fees, as well as the plan’s “outputs,” its ability to achieve the plan’s desired objective.

For instance, plan fiduciaries should target having 90% to 100% of eligible workers participate in the company’s defined contribution plan. For the record, just 63.5% of workers participate in plans not using auto-enrollment and 81.4% of workers participate in plans with auto enrollment. It would be a worthwhile exercise to check your plan’s participation rate.

Check too on the plan’s overall deferral rate; how much workers are contributing to their 401(k) plan. On average, workers defer around 7%, according to various studies. But the authors of the DCIIA report said plan fiduciaries should strive for average total deferral rates of 10% to 15%.

Plan fiduciaries must also monitor whether workers are investing wisely in their 401(k) plans. The reason why might be obvious, but it’s worth noting what the authors of the DCIIA report wrote: “Non-diversified portfolios can be adversely impacted in times of market volatility.”

Plan fees must also be monitored, especially since high fees can “erode participant balances.” So, check whether you plan fiduciary is periodically evaluating whether the fees paid for the services received are reasonable, via peer-based benchmarking or other market-based analyses. If not, you should ask why not. By law, they have to.

Also check whether your plan fiduciary is educating workers about income-replacement ratios. That would be the percent of pre-retirement income workers might need to enjoy a comfortable retirement. “A traditional income-replacement goal is 80%, but this varies by individual, and is based on supplemental sources of income, including those from defined benefit plans and Social Security payments,” wrote the author of the DCIIA report.

And lastly, check whether your plan fiduciary is addressing something called “retirement readiness.” “The philosophy of a successful plan goes beyond the accumulation of savings and focuses on retirement readiness — helping participants become financially prepared for retirement, wrote the author of the DCIIA report.

And your being financially prepared for retirement is, at the end of the day, the best sign that you have a best-in-class 401(k).

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