Employees nearing their expected retirement date face sobering consequences when their defined contribution retirement plans are underfunded, as many are. How underfunded? One scary number, from a TD Ameritrade December 2012 study, quoted in a Prudential Retirement White Paper, suggests that "the average baby boomer is $500,000 short in their retirement savings."

This underfunding creates a problem for the employer too. Large numbers of employees may decide they want to close their retirement income gap by delaying retirement. The White Paper cites Financial Finesse Reports figures from 2011 estimating a cost of $10,000 to $50,000 per employee, per year, for every year a retirement is delayed.

Prudential notes that delayed retirement costs include higher health care expenses of older workers, as well as productivity costs such as the demoralizing effect on younger workers and the inability of the company to hire new talent.

It's a problem for employers in the short term because the number of employees over age 55 is expected to grow by more than 40% by 2018, the White Paper states. But it can only be solved over the long term as employees (and employers through their matches) are able to inject more into their DC plans.

Plan providers have spent the last several years pounding home to consumers-both in the general media and in direct messages to participants-the message that they need to put more into their DC plans. Prudential Retirement's White Paper shifts the discussion away from the employee to focus on solutions that are under the control of the employer. The White Paper is titled "Overcoming Participant Inertia-Automatic Features that Improve Outcomes While Improving Your Plan's Bottom Line."

It makes a strong mathematical case for the use of both auto-enrollment and auto-escalation of the employee's plan deferral amounts. Using Prudential's own data from 2012, it compares two hypothetical employees, age 39 and age 47, each earning $50,000 per year. (Prudential points out that auto-enrollment drives down the average age of plan participants; for 2012 the average age for auto- enrollees was 39; for plans without auto-enrollment, it was 47.)

Each has a 3% salary deferral and a 50% employer match up to the first 6% of salary. At age 65 the employee who started contributing at age 39 would have approximately $83,000 more than the employee who started at age 47.

When the same plan uses both automatic enrollment and automatic escalation of deferral amounts, the account value differential is even more dramatic. When the original 39-year-old employee tacks on a 1% annual auto-escalation of deferrals up to a maximum of 10%, their balance at retirement exceeds that of the original 47-year-old by roughly $250,000.

The White Paper asks, "Why, with such a compelling data case, do only 44% of plans offer an automatic enrollment feature (according to a 2011 survey of plan sponsors by the Defined Contribution Institutional Investment Association), and fewer still offer both auto-enrollment and auto-escalation?"

Having more employers install these automatic tools could enhance employees' retirement readiness, but for employers to make significant alterations to their retirement plans, they need to fully understand the purpose for doing so. For that to happen, plan advisors must redirect the discussion they have with plan sponsors, says Harry Dalessio, senior vice president, sales and strategic relationships, for Prudential Retirement.

"The role of the advisor is changing. Those advisors who can change the conversation with their clients from a tactical approach to a strategic approach focused on retirement readiness and plan optimization will add real value to the plan sponsor." In the past, Dalessio continues, "there's been so much emphasis on the tactical blocking and tackling on a day-to-day basis. We think this is an opportune time to step back and change to a more strategic focus.

"Plan sponsors want to look at their overall spending on benefits. How are they optimizing it? How are they driving the outcomes they want for their employees? That will be different from employer to employer."

Dalessio says property/casualty brokers are among those with a big opportunity to have this kind of conversation with retirement plan sponsor companies. Some of these P&C brokers have their own retirement practice, while others partner with an outside retirement advisory firm, he notes.

"These P&C firms are used to working with the finance executives at the plan sponsor company. Finance executives are keenly interested in their cost of participant behavior, when people retire, how they're preparing them to save, the impact that may have on their bottom line, and how the employer can influence employee choices.

"A number of P&C firms have embraced this strategic approach to working with retirement plan sponsors. They are really beginning to have a strong market impact on retaining clients, adding new clients, as well as extending the franchise of their firm from P&C into retirement planning."

Dalessio says the focus should be on the interests and welfare of the individual employees who will be entering retirement in the future. "For so many years our industry was focused on the X's and 0's-the return of the fund, the five-year number, the alpha, the beta, the participation rate. What was lost was the 'face' of that employee. What are their hopes, their dreams?"

The White Paper makes clear that as an advisor or broker works strategically with the plan sponsor to address the issue of underfunded plans, it's likely to take more than quick conversations. For example, the White Paper anticipates that sponsors considering adding auto-enrollment and/or auto-escalation of deferrals may be concerned about the risk of employee opt-outs and the risk of higher costs.

In general, Prudential's data refutes the concern that employees are likely to opt out of a DC plan because of the auto-escalation feature. "Across all Prudential Retirement defined contribution plans there is an average opt-out rate of 8.1%. For those plans offering both auto-enrollment and auto-escalation features, the average opt-out rate falls to 7.0%," the White Paper states.

It cautions, however, that many variables among individual plans must be considered when establishing the auto deferral rate and escalation percentage, including the company's match rate. "The challenge is to identify the 'optimal' default deferral percentage that will increase deferrals without adversely impacting plan participation."

It suggests that one way to control the cost of employer matches when implementing auto-enrollment and -escalation is to create a tiered matching formula based on employee age and years of service. Again, the composition and needs of each workforce must be analyzed individually.

Prudential's White Paper points out that when an employer facilitates broader participation in its DC plan, it can benefit a wide swath of plan participants-not just those whose balances are the most underfunded. For example, the study notes, "It may positively impact the ability of highly compensated employees to contribute more to the plan, providing a valuable added inducement to the organization's key constituencies while improving nondiscrimination results."

The next few years should prove to be an interesting laboratory for the working of the retirement system. Waves of Baby Boomers are scheduled to retire. Behind them are the Millennials, with their own set of financial pressures and expectations. Both employees and employers will be grappling for solutions to the problem of underfunded retirement accounts.

Dalessio says that for Prudential and the intermediaries it works with, "there's a big opportunity to focus on plan sponsor outcomes and how those directly impact participant outcomes to drive a better long-term strategy for their client."

The author
Thomas A. McCoy, CLU, retired in 2013 as editor-in-chief of Rough Notes magazine.