Hesitant about autoenrollment? Try myth busting.

March 8, 2022

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Employers want it for their employees and employees want it for themselves—retirement success. But while both share the same goal, how employees achieve retirement readiness can vary greatly.

So, what's the best way for plan sponsors to positively impact the retirement readiness of their participants? Vanguard believes it's with thoughtful plan design that incorporates automatic enrollment.

Automatic enrollment leverages learnings from behavioral finance to encourage retirement saving. It reframes the saving decision by directly enrolling employees into their retirement plan, with the right to opt out anytime. Combined with an automatic increase feature and an age-appropriate, well-diversified target-date fund, automatic enrollment can help employees create a strong retirement savings foundation that offers undeniable benefits.

Employees hired into an automatic enrollment plan design participate at levels almost 50% higher than those hired into a voluntary design (92% versus 62%), and they save an average of 57% more, according to the upcoming edition of How America Saves, our 21st annual analysis of retirement saving behavior in Vanguard-recordkept plans. Over the past 15 years, automatic enrollment has grown in popularity. As of year-end 2021, 56% of plans at Vanguard had incorporated this pivotal strategy, with 75% of larger plans (1,000 or more participants) implementing it. The trend is clear.

The growing adoption of automatic enrollment in Vanguard DC plans

The growing adoption of automatic enrollment in Vanguard DC plans

As of December 31, 2021.
Source: Vanguard.

Still, some plan sponsors remain hesitant to implement autoenrollment? Why? The answer lies in a mix of important considerations and persistent myths. Let's look at some of these issues and Vanguard's suggested solutions to address sponsor concerns.

Myth No. 1: We don't need it

Some plan sponsors feel their eligible employees are saving enough on their own, or that the generosity of nonelective contributions such as profit-sharing or pension contributions fills any retirement saving gaps. In fact, the main reason more than half of respondents gave for not offering automatic enrollment was their belief it was "unnecessary," according to a 2019 Callan study.

However, plan sponsors may have an exaggerated sense of how successful their outcomes are with a voluntary enrollment design.

First, examining participation rates shows there are dramatic differences between the rates of plans with voluntary enrollment and those with automatic enrollment.

When a plan implements an automatic enrollment design, participation rates are typically above 90%. This percentage can also serve as a suitable threshold for what would be seen as a successful participation rate. However, only about 1 in 4 voluntary enrollment plans have a participation rate of 90% or higher—compared with 3 in 4 plans with automatic enrollment.

Participation rates by plan design in Vanguard DC plans

Participation rates by plan design in Vanguard  DC plans

As of December 31, 2021.
Source: Vanguard.

By implementing an automatic enrollment design, most voluntary enrollment plans could materially improve their participation rate.

In addition, employees in automatic enrollment plans save an average of 10.7%, compared with 6.8% for those in voluntary enrollment plans. Therefore, employees of a company that provides automatic enrollment design save 57% more than those in a plan with a voluntary design.

Myth No. 2: Automatic enrollment costs too much

Because automatic enrollment improves plan participation, there is a concern that associated employer matching costs will strain a firm's finances. But it is important to consider the characteristics of the employees that would not necessarily enroll in a plan on their own. Disproportionately, higher-paid participants enroll in voluntary plans.

Participation rates by employee pay and plan design in Vanguard DC plans

Participation rates by employee pay and plan  design in Vanguard DC plans

As of December 31, 2021.
Source: Vanguard.

Switching from voluntary enrollment to automatic enrollment will typically add, on a relative basis, lower-paid employees to the plan. So, the associated additional matching costs will be somewhat diluted because a large number of the new plan participants will be lower paid.

See the example below, leveraging data from How America Saves. Assuming a voluntary enrollment plan has a participation rate of 65%, if the plan were to implement an autoenrollment design and sweep in current nonparticipants, the plan sponsor might anticipate that enrolling most nonparticipants into the plan could increase the total costs of their employer matching contributions by approximately 50%. However, given that the nonparticipants are lower paid, the total impact to the employer match in this scenario would only increase 21%, less than one-half of the anticipated result.

ABC 401(k) plan

Participant and nonparticipant average salaries based on data from How America Saves.
Scenario assumes all participants defer 6% or more.
Scenario assumes a nonparticipant sweep opt-out rate of 15%.

In addition, costs may be a concern for plan sponsors that experience higher than normal turnover. Implementing an automatic enrollment solution in plans with high turnover could result in costly administrative processes that involve either cashing out participants, tracking down lost participants, or retaining relatively low balances above the cash-out limit. And as turnover continues to increase in the post-pandemic economy, concern could increase.

There are solutions to help mitigate the new costs, such as delaying the match eligibility, adding a vesting schedule, or implementing after a set period (for example, two to three years of tenure).

Myth No. 3: Employers don't want to force employees to save for retirement and employees don't like feeling pressured to do so

Employers may feel that automatically enrolling employees into a retirement plan is overly paternalistic or beyond their charge. They most likely have genuine concern for their employees' ability to retire comfortably but see automatic enrollment as overly forceful. In this case, the question is: Do employees want to save for retirement?

On the surface, analyzing the participation rate of employees hired under a voluntary enrollment design confirms that more than one-third of employees (38%) choose not to save for retirement. But behavioral finance research provides several explanations for this choice, such as lack of planning skills, default decisions, and inertia and procrastination.

Voluntarily enrolling in a retirement plan typically involves some complex choices. Some considerations are logistical: How does the plan work? How do I enroll? But employees also may ask: How much should I save? How should I invest my contributions? These are not easy questions and, in addition to the inherent procrastination of human behavior, can delay retirement savings, even when employees understand the value of saving for retirement.

Vanguard research shows that when comparing participation rates across various job tenure segments, only about one-third of employees who have less than two years on the job participate in a voluntary enrollment plan, compared with nearly 9 in 10 in an automatic enrollment plan among the same demographic segment.

However, more than 3 in 4 employees with at least 10 years of tenure participate in a voluntary enrollment plan. This data suggests that over time, most employees will sign up for their retirement plan, recognizing its value and importance.

By simply adding an automatic enrollment feature, employees are kick-started into saving for retirement sooner, and, given the power of compounding, those first few years can be the most valuable for saving long term for retirement.

And finally, only 8% of employees in an autoenrollment plan opt out, reinforcing that employees value the action of saving. If there was concern that employees would not like to participate in a retirement plan, this opt-out rate would be much higher.

Going beyond automatic enrollment

Let's assume we've addressed the concerns some plan sponsors may have regarding automatic enrollment.

What's next?

For plan sponsors to maximize automatic enrollment, they should ensure it is part of a smart plan design. This means defaulting employees to at least the employer match level and automatically enrolling them into an automatic escalation feature designed to accelerate their total savings, with employee and employer contributions, to at least 12%–15% as quickly as possible.

In addition to savings, participants could be hesitant to enroll because of lack of knowledge or confidence in their investment acumen and uncertainty about how to invest their contributions. Of plans that offer automatic enrollment, 98% default participants into a target-date fund, providing an age-appropriate, diversified investment portfolio.

And target-date funds also encourage participants to "stay the course."

During the extremely volatile financial markets in 2020 caused by the COVID-19 pandemic, target-date fund investors were four times less likely to trade, even amid acute economic and market stress. This bodes well for participant outcomes because in times of volatility, the automatic rebalancing of target-date funds spares investors the emotionally challenging task of rebalancing on their own. Only 4% of pure target-date fund investors traded in their accounts during the year, compared with 16% of all other investors, according to our analysis of Vanguard-recordkept plans.

A strategy with a bright future

Vanguard strongly believes that automatic enrollment is crucial to strengthening the retirement savings of workers and encourages plan sponsors to consider this valuable plan design. There have also been recent legislative and regulatory developments further signaling the availability of automatic enrollment.

The Pension Protection Act of 2006 offered significant support for automatic enrollment. Now this support may be strengthened by a provision in the new proposed legislation known as the SECURE 2.0 Act. This proposed law would mandate that virtually all new plans will need to be automatic enrollment plans.

In summary, plan sponsors should consider the following actions:

  • Autoenroll at least at the level of the matching contribution. Identify your participation rate. If it is under 90% and you do not already have autoenrollment, implement it with a default rate at least at the level of the employer match (or 6%).
  • If your plan currently has an automatic enrollment design, consider the attributes of the design. Between the initial enrollment default percentages, automatic increase, and employer contributions, how quickly will employees reach an appropriate total savings level (at least 15%) without self-direction? The quicker that participants can reach stronger saving rates, the more prepared they will be to retire.
  • Weigh alternatives. If automatic enrollment presents cost challenges, consider solutions such as delaying match eligibility, vesting schedules, and delayed implementation.

Vanguard Strategic Retirement Consulting (SRC) group is here to help. We recognize that each plan is unique and may have its own circumstances to consider. SRC helps plan sponsors develop fiduciary best practices, ensure regulatory compliance, and collaborate to optimize plan design—to ensure plan sponsors can provide their employees with the best chance for retirement success.


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