Retirement Plan Account Balances: Big and Small
Advisors have a variety of tools at their disposal to determine the overall health of a plan sponsor’s retirement plan. However, there is a time-tested exercise that only takes about a minute to complete: review the current account balances of all the participants in the retirement plan and complete, what I call the “big and small” analysis. What is a “big and small” analysis? Simply put, it uses a quick snapshot of the big ($200,000+) and small (under $10,000) account balances to determine a plan’s health. Typically the ratio of big to small account balances is 10% to 40%.
If a plan is fairly mature (i.e., it has been around for 40 years or more) and there are more than 10% with big balances and less than 40% with small balances, it is relatively safe to assume that it is a healthy retirement plan. And that is without reviewing investments, retirement savings rates, retirement readiness calculations, or anything else.
Of course, there are exceptions to the “big and small” rule. For example, if the plan disproportionately consists of older and long-tenured employees (both of which tend to have higher account balances, which could offset the “big and small” analysis), then some further digging may be required to determine the plan’s overall health.
However, in most plans, there are going to be fewer big account balances than small. So, what conclusions can we draw regarding a plan’s health when, for example, fewer than 5% of employees have account balances of $200,000 or greater and more than 50% of employees have balances of $10,000 or less? This “big and small” analysis may not necessarily indicate that the plan is inadequately preparing participants for retirement, but could instead be due to the fact that the organization does not employ employees that start young and stay with the company for most, or all, of their working careers. However, if the participant demographic of a retirement plan contains mostly long-tenured employees, and the big and small ratios are still missing the mark, it could be a sign that the retirement plan is deficient in some area.
What if there are many small account balances and many big ones as well? This could be the result of an otherwise healthy plan that is using auto-enrollment (which can lead to many small balances), or one that does not has a small balance cash-out provision (or does not enforce it), or both. If there are few small and big account balances, then the plan is not likely to be mature (i.e., it has been around less than 20 years), does not use auto-enrollment and has a cash-out provision that is strictly enforced.
The “big and small” analysis should be used as a starting point to help frame a deeper plan assessment to identify the root causes of positive and negative attributes and a future course of action. However, there is a lot that can be assumed about a plan simply by looking at its “big and small” account balance ratio.
Why is account size so important? At the end of the day, a plan can have the “best” investments and the “best” plan design, but if participants are not accumulating wealth in the form of their account balances, the retirement plan is not doing its job.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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