Automatic enrollment has redefined 401(k) plans. However, this popular feature’s benefits don’t need to stop after an employee is hired. Instead, they can continue throughout the employee’s career in the form of additional automatic saving solutions.
Complex choices and general procrastination are two primary reasons why employees may be hesitant to voluntarily sign up for their retirement plan. But by leveraging the power of human inertia, automatic enrollment has led to undisputable success, as demonstrated by an examination of Vanguard retirement plan data as of year-end 2021.
- 93% of employees hired under an automatic enrollment design participate in the plan, compared with 66% hired under a voluntary enrollment plan.
- Employees who work for a company that offers automatic enrollment save nearly 50% more than those who work for a firm with voluntary enrollment. (10.9%, compared with 7.3%)
Fifty-six percent of plans had implemented an automatic enrollment design, and among plans with at least 1,000 participants, 75% of plans used the feature. And as plans continue to adopt automatic enrollment, plan sponsors are also increasing their default percentages. Fifty-eight percent of automatic enrollment plans now default at rates of 4% or higher, nearly twice as many as a decade ago.
Given the benefits that automatic enrollment plans provide employees, are there additional ways that plan sponsors can leverage the power of inertia in their employees’ favor? Absolutely!
There are three common types of automatic saving solutions:
- Reenrollment. Automatically enroll current nonparticipants into the plan.
- Undersaver. Increase low-saving participants to the maximum employer match value.
- Automatic increase. Enroll participants into an automatic increase feature.
As the financial health of workers and their households change for various reasons (life adjustments, job changes, spending habits, etc.), automatic solutions can serve as valuable plan design features that help participants regain their footing and improve retirement saving behavior. This commentary explores each of the three types of automatic saving solutions and provides Vanguard’s success rates based on recent plan actions from 2021.
Reenrollment
Upon being hired, some employees may feel that they are not in a financial position to save for retirement. Perhaps they are more concerned about building an emergency savings account or that their current debt is difficult to manage, and they prefer to prioritize these types of financial concerns over retirement savings.
However, over time the financial health of employees can change, and while retirement savings may have been a less prioritized concern at the time of hiring, employees may now have the financial bandwidth to start saving for retirement. Unfortunately, procrastination and feeling overwhelmed when making complex choices (how much to save and how to invest) can interfere with positive actions and delay retirement saving.
Reenrollment sweeps target current nonparticipating employees and provides them with the decision to opt out of the plan. But if they choose to do nothing, they are automatically enrolled in the plan at the default rate and invested in the plan’s default fund.
In 2021, 17 plans implemented a reenrollment sweep, targeting more than 5,200 current nonparticipants. As a result, 84% were enrolled into the plan as just 16% of employees opted out and chose not to participate.
While this automatic solution would not be expected to return a success rate equal to the overall automatic enrollment rate of 93%, providing a success rate of 84% is an incredible result considering the population was all current nonparticipants.
Undersaver
Eighty-five percent of 401(k) plans provide an employer matching contribution. These retirement benefits are crucial to helping employees save sufficiently for retirement, and it is recommended that workers save at least enough to receive the full employer match. In fact, even if workers need to build up an emergency savings account or pay off debt, Vanguard recommends prioritizing savings at least to the employer match level.
In 2021, 3 in 10 participants saved below the employer match level of their plan. There are various reasons why participants may not maximize this retirement benefit.
First, while plans continue to raise their initial default rates, 3% is still the most common default—and that is below the rate at which most participants would need to save to receive the full match. And 3 in 10 automatic enrollment plans did not automatically enroll employees into an automatic increase feature, causing participants who “do nothing” to continually save at a low rate. In addition, some participants may feel that they cannot save enough to maximize their employer match and choose to save at a lower rate or may simply not fully understand how their employer matching contribution works.
Undersaver sweeps are designed to help participants realize the full value of their employer match and are typically designed to automatically raise their deferral to the rate at which they’ll receive the maximum match. In 2021, 14 plans, representing more than 9,100 participants, automatically increased low-saving participants to the rate necessary to receive the full employer match. Overall, 78% of participants had their deferrals increased, as fewer than 1 in 4 participants opted out.
While saving at the employer match rate may not necessarily be the optimal total saving rate for many participants, it is an important first step to maximizing retirement benefits, and, in most cases, moves them closer to their optimal saving rate. And, when combined with an automatic increase feature, participants can eventually reach strong saving rates.
Automatic increase
Participants should target a total saving rate of 12% to 15% or more. As of year-end 2021, the median total saving rate of participants was 10.4%, meaning one-half of them were saving below 10.4% and most likely were not saving enough to ensure retirement sufficiency. Automatic increase is a powerful, inertia-based feature that annually increases participant deferral rates by 1% to 2% to a predetermined cap.
Seven in 10 plans that implement an automatic enrollment plan also automatically enroll participants into an automatic increase feature, and 8 in 10 plans set an increase cap of at least 10%. Automatically escalating participant deferral rates helps to increase savings. Our research shows that participants enrolled in a plan with automatic increase save, on average, 20% to 30% more after three years in a plan, compared with participants in an automatic enrollment plan that does not automatically enroll participants.
The two common deferral rates among participants are 10% and the maximum employer match level. While a 10% employee deferral is a strong saving rate for most employees, saving at the maximum match level, while an important first step, is most likely not an optimal saving rate. In 2021, the average employer match rate was 4.4%, and the maximum employee deferral rate to receive the full value of the match was typically in the range of 4% to 6%. Therefore, for participants to reach total saving rates of 12% to 15%, most employees need to save above the maximum match level, unless the plan offers extraordinarily generous employer contributions.
Enrolling participants into an automatic increase feature, typically ranging from the match rate through just below the automatic increase cap, helps participants slowly increase their saving to optimal levels. Annually increasing deferral rates, which can coincide with pay raises to help offset the financial take-home pay impact, can strengthen savings and improve retirement readiness. Moreover, implementing an automatic increase sweep typically does not increase employer match costs as the increases only impact participants that are at or above the maximum employer match rate.
In 2021, 19 plans, representing more than 22,500 participants, implemented an annual increase sweep for participants. Overall, 94% of participants maintained the increase, and only 6% of participants opted out of the feature.
Conclusion
As automatic enrollment continues as a widely successful design, leveraging the power of inertia to participants’ benefit, automatic saving solutions can further strengthen retirement outcomes and ensure that as participant financial health changes over time, they are provided with positive actions that can help improve their retirement saving behavior.
Vanguard recommends these plan design actions every three to four years, which helps ensure a reasonable amount of time between instances while not extending the period too long to miss saving opportunities.
Strong retirement savings boils down to two important actions: saving enough and investing appropriately. Automatic enrollment into a target-date fund and subsequent automatic saving solutions helps ensure participants have plenty of opportunities to achieve their goals.
Notes:
- All investing is subject to risk, including the possible loss of the money you invest.
- There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- 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 target-date funds is not guaranteed at any time, including on or after the target date.