In many ways, the US shares similar issues to those of South Africa, and a low personal savings rate is one of them. Addressing the issue at the Sanlam Investments Institutional Insights conference in Johannesburg this month, was Sonja Kellen, a leader in Microsoft’s drive to boost the number of contributors to the company’s pension plan.
Kellen, Director of Global Retirement Benefits at Microsoft, was faced with the challenge of having to convince the company’s 60,000 US employees that they would not only have to increase their personal savings but up their contributions to their employer’s pension fund to cover their post-retirement needs. However, several headwinds needed to be addressed.
The US government’s Social Security programme, launched in the 1930s, covers all working employees — but, as Kellen explained, it falls far short of meeting the needs of most retirees. Under the plan, just 6.2% of each employee’s earnings is deducted, and from the age of 62 retired people can draw an annuity-like payment. The trouble is, the state’s “pension” is capped at a set maximum, which means many retirees will receive just a fraction in retirement compared to what they were paid as contributing employees.
For this reason, people needed to save a lot more. Sadly, however, Kellen reported that the average personal savings rate in the US had in fact declined to a mere 4% of earnings and over 75% of Americans report that they cannot even cover six months of living expenses. A far more realistic personal savings rate should be 5-9%, she said.
Which is why the onus to increase personal savings — and to take care of the fiduciary responsibilities that come with it — has fallen on US employers’ pension schemes. The hitch in this grand nationwide plan, legislated as far back as 1875, is that only 58% of working Americans are in a company retirement fund at all.
The auto-enrolment trend
Over the years, many US companies have opted to auto-enrol their employees, and sometimes in plans whose investments consisted mainly of their own stock. The collapse of Enron in October 2001 and the lawsuits that followed, enticed the US government to enact legislation that put pressure on additional restrictions on companies’ abilities to invest their employees from their employer’s shares. Companies would then have to diversify their plans into more “prudent” retirement portfolios and therefore take on a vastly bigger role in compliance. Defined-contribution plans now make up 27% of US retirement assets.
An investment menu of choice
The Microsoft plan comes in the form of an easily accessible internet portal. On it, employees can choose from a three-tier investment menu. Firstly, to set a target date for retirement — intended as a simple age-related way for inexperienced investors to enter the savings system. Secondly, for more investment-savvy employees, is to offer a choice of core strategies that clearly spell out risk parameters, performance objectives and associated fees. The third option is to set up specialised investment and brokerage accounts.
Kellen and her team at Microsoft came up with a tech-smart solution “Easy Enrol” that gets people into the plan quickly with a strong and increasing savings rate, and into their age-appropriate target date fund.
“The three pillars of the plan’s success is that it enables employees to enrol quickly, find an appropriate rate of savings, and get invested in an age-appropriate diversified portfolio,” said Kellen.
The role of behavioural finance
Cleverly, Kellen and her team applied several key behavioural finance insights to perfect the system. They realised, through research, that whatever was placed first in a menu of options would most likely be chosen. So they placed the highest percentage contributions first to increase the much-needed savings rates. They subsequently discovered that two-thirds of members chose a 12% savings rate, simply because this rate was placed first; it acted as a visual prompt.
With three simple clicks, members could select their savings rate, set up annual increases and choose target-date funds appropriate for their age, etc. So people enrolled faster and saved much more than before. The scheme now has $13.6-billion in assets under management. To date it has attracted 91% of Microsoft’s American employees, whose average savings rate is 12% of their salary. Interestingly, younger members choose even higher savings rates, said Kellen.
Costs have been driven down by focusing on efficiencies in the process and structures, including a gradual shift of investable assets into indexed strategies. In this way, Kellen said Microsoft managed to balance innovation in member savings and plan design while still meeting their compliance burden.