Tuesday, September 26, 2017

Small businesses. Mighty retirement plans.

Small businesses account for 99.7% of all employer firms and 64% of all private-sector employees, according to the Small Business Administration (SBA). So how are small businesses preparing their employees enrolled in defined contribution (DC) plans for retirement? And how effectively are small- business employees using this benefit? Vanguard addresses questions surrounding small-business retirement behavior in its recent research How America Saves 2017: Small business edition

A supplement to How America Saves 2017, this edition focuses on trends relevant to Vanguard Retirement Plan Access™ (VRPA) clients, who include small- to mid-size plan fiduciaries. Not surprisingly, given the SBA statistics, VRPA has seen significant growth since its inception in 2011. VRPA served more than 6,500 retirement plans and more than 270,000 participants by the end of 2016.

A testament to VRPA’s success is the overall consistency of participation rates and other measures between VRPA clients and the corporate behemoths that feature more prominently in the parent publication How America Saves 2017. The data similarities in each of these studies suggest small- and large-company plan sponsors are on target in preparing their employees for retirement.

For example, VRPA participants saved, on average, 6.9% of their income in their employer’s plan versus the 6.2% participant deferral rate for large-company participants. Both VRPA and large-company employees shared a median deferral rate of 5.0%. In other words, small-business participants were doing well in these measures even without the scale of administrative and educational resources available to the largest corporate plans.

Participant employee-elective deferral rates

Employee-elective deferral rates bar chart

At year-end 2016, participants in both large and small companies allocated roughly three-quarters of their plan contribution assets in equities, including the equity portion of balanced funds. About half of all contribution dollars, for both large and small companies, were in target-date funds (TDFs).

Plan contribution allocation summary

Plan contribution allocation summary chart

In 2016, 88% of terminated VRPA employees eligible for distributions and 90% of large-firm employees preserved their retirement assets either by rolling them over to an IRA or by keeping them in the employer’s plan.

These are a few examples that show how small businesses measure up to larger ones. The findings from How America Saves 2017: Small business edition show how small-business sponsors and advisors are preparing their employees for retirement readiness through strong plan design.

Strength in plan design

Retirement plans administered by VRPA are divided into two populations: start-up plans, which began within the last three years, and established plans, which began more than three years ago. Altogether, the average VRPA plan has 42 participants and $2.3 million in plan assets.

Since VRPA’s 2011 inception, each plan has gone through plan design or review, which speaks to the consistency in annual data. Research highlights show the influence of plan design on participation and accumulation within small-business plans.

In 2016, three-quarters of VRPA plans offered employer match contributions at an average value of 4.8%. In 2015, 72% of VRPA plans provided employer match contributions, with an average contribution value of 5.8% and median value of 3.5%.

Plan participation within small- and mid-sized companies improved with age and job tenure. In both 2015 and 2016, 8 in 10 employees with ten or more years on the job participated in their company’s plan, while about half of employees with two or fewer years were enrolled. Employees ages 45 to 64 were the largest age group enrolled, with 7 in 10 participants both years. Employees younger than 25 accounted for only 38% of plan participants in 2016 and 45% in 2015.

Automatic enrollment helps get employees into the plan, but the data show most employees could be saving more by increasing the 3.0% default deferral rate. The average deferral rate for automatically enrolled employees was 5.7% to 22% lower than voluntarily enrolled employees, with an average 7.3% deferral rate in 2016. Deferral rates from 2015 were nearly identical. Previous research has shown higher default rates don’t lead to higher quit rates.

VRPA plan participants could choose from 20.2 investment options, on average, by year-end 2015 and 2016. The median plan sponsor offered 19 options in 2016 and 20 in 2015. Only 6% of plans offered 10 or fewer investment options, while 1 in 5 offered more than 25.

Of the investment options on the VRPA plan menu, nearly all small- and mid-size employer plans (99%) offered TDFs in 2016, a two-percentage-point increase from 2015. And three-quarters of their employees were invested in TDFs.

TDFs have become a regular fixture in the small-business employee’s investment lineup. But perhaps the most notable area VRPA plans are seeing improvement is in portfolio construction. In 2016, 80% of participants had broadly diversified portfolios, as more portfolios have professionally managed allocations. Less than 1% of participants were heavily invested in company stock. The chart below shows the allocation breakdown.

Participant portfolio construction

Portfolio construction pie chart

The year-over-year data consistency within How America Saves 2017: Small business edition indicates small-business plan sponsors continue to optimize their retirement plans through strong plan design. More details on small-business retirement behavior are available in the complete report.

  •  All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
  • Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the target-date funds is not guaranteed at any time, including on or after the target date.