BUSI 688 Week 3 DB Forum 2 Example

Discussion Board Forum 2: Thread and Replies

BUSI 688 Retirement Planning, Discussion Board Forum 2 (thread and two replies)

Thread by [Student Name]

The forum topic, the employer and the classmates are composites standing in for the course's own; the plan rules described are those of SECURE 2.0 and the Department of Labor's default investment regulation, and the textbook and research cited are real; the requirements follow Liberty's public course guide for BUSI 688.

Thread

The topic describes a composite manufacturer with 120 employees adopting its first 401(k). The owners must set five defaults: whether to enroll automatically, the starting contribution rate, the annual increase, the default investment and the match. Dalton and Dalton (2018) describe these as plan design choices that shape both cost to the employer and outcomes for participants.

Some choices are no longer optional. Since the 2025 plan year, SECURE 2.0 has obliged the great majority of 401(k) plans set up after late December 2022 to sign up eligible workers automatically, at a starting rate between 3 and 10 percent of pay, increasing by one point a year until it reaches at least 10 percent, with a cap of 15 percent. The law spares very small employers, those with ten or fewer workers, and businesses under three years old, but this manufacturer fits neither exception. Participants can still opt out or choose a different rate, so the law sets the starting point rather than forcing anyone to save.

Why the defaults matter so much is the central finding of Choi et al. (2002). Studying how participants responded to plan rules, they found that employees overwhelmingly followed the path of least resistance: automatic enrollment raised participation, but participants also tended to keep whatever contribution rate and investment the plan chose for them. A default rate is not where most workers start; it is where most of them stay.

I saw this at my first job, where the plan enrolled everyone at 3 percent in a money market fund. Years later, many of my coworkers were still at 3 percent in cash, earning almost nothing, because changing it required a decision nobody made.

My recommendations follow. Enroll everyone automatically at 6 percent, which is within the legal range and above the 3 percent that research shows can anchor savings too low. Escalate by one point a year to 10 percent. Use a target-date fund as the default, which can qualify under the Department of Labor's default investment rules and gives the employer fiduciary protection for that choice. Put a full match on deferrals up to 3 percent of pay and a half match on deferrals from 3 to 6 percent, so workers capture the full match at the default rate of 6 percent. Finally, re-enroll existing employees who opted out after one year, giving them another chance to accept the default. The cost of the match at these rates is predictable, and the owners can estimate it from payroll before the plan launches, which lets them choose the formula with their eyes open.

Reply to Ashley

Ashley, your thread recommended starting automatic enrollment at 3 percent, the legal minimum, to keep workers from opting out because their paychecks shrank. That concern is reasonable, and your experience as an HR coordinator handling complaints after a plan change gives it weight. But research on defaults suggests the trade-off runs the other way. Choi et al. (2002) found that participants tend to stay with the plan's chosen contribution rate, so a 3 percent default can hold savings down among workers who would have chosen more if left to decide actively. Most of the workers who keep a default do so because they never revisit it, not because they prefer it, which is why the plan's choice carries such weight. Dalton and Dalton (2018) note that the match formula can be set to reward a higher rate. If the plan matches up to 6 percent, a 3 percent default leaves half the match unclaimed for every worker who stays put, which is free money lost. A 6 percent start, with the match designed so that the default captures all of it, is likely to cause few additional opt-outs while doubling the savings of those who stay. If opt-outs are the worry, the plan could start at 4 percent and escalate faster. At my current employer, raising the default from 3 to 6 percent produced only a handful of opt-outs. Your concern about complaints is legitimate, and a clear explanation in the enrollment packet of how the match works would answer many of them before they arise. Would you consider testing a 6 percent default for new hires first?

Reply to Brian

Brian, your thread argued that the employer should use a money market fund as the default because a target-date fund could lose value and expose the owners to lawsuits. I understand the worry; plan sponsors are fiduciaries, and your example of a friend's employer sued over high plan fees shows the risk is real. But a cash default carries its own risk, and the regulations favor the alternative. Inflation alone erodes a cash balance over a career, so a worker who stays in money market for thirty years may end up with far less purchasing power than one who accepted market swings. Dalton and Dalton (2018) describe qualified default investment alternatives as investments that give sponsors fiduciary relief for assets placed by default, and target-date funds are a common qualifying choice, while a money market fund generally qualifies only for a limited period after a participant's first contribution. Choi et al. (2002) found that participants tend to leave their money where the plan puts it, which means a cash default would likely remain the investment for years and grow far too slowly for retirement. The real fiduciary risk lies in choosing a target-date series with high fees or without monitoring it, which the sponsor can manage through a written investment policy and an annual review. A default that is safe from short-term loss but almost certain to leave workers short in retirement is not truly safe for them. Would a low-cost index target-date series, reviewed each year by an investment committee, address your concern about liability? Documenting that review in meeting minutes is what demonstrates the prudent process the law expects of fiduciaries.

References

Choi, J. J., Laibson, D., Madrian, B. C., & Metrick, A. (2002). Defined contribution pensions: Plan rules, participant choices, and the path of least resistance. Tax Policy and the Economy, 16, 67-113. https://doi.org/10.1086/654750

Dalton, M. A., & Dalton, J. F. (2018). Retirement planning and employee benefits. Money Education.