How America nudges employees to save for retirement

Now, in the third article of the series, we focus on how much employees contribute to their retirement plans—their deferral rate. Employees are the main source of funding in a typical defined contribution plan, so their deferral rate is critical in determining whether plan participants will save enough for retirement. We recommend that participants save at least 12% to 15% of their pay, including both employee and employer contributions, to meet their retirement goals.

How America Saves 2024 reveals several encouraging plan design trends, including automatic enrollment adoption, enrollment defaults, employer contributions, immediate eligibility, and participant access to professionally managed allocations (see Figure 1).

But the adoption of another notable plan design feature has remained flat. Among Vanguard plans that offered automatic enrollment in 2023, 69% enrolled participants with automatic annual increases, which raise an employee’s deferral rate each year by a certain percentage.¹ (Automatic increases typically boost participant deferral rates by 1% or 2% annually.) That figure was also 69% in 2013.

Figure 2 shows, by industry and by plan size, the percentage of plans that offered automatic increases in 2023, with data drawn from our industry benchmark reports.

Automatic annual deferral rate increases are a powerful feature that can help improve participants’ chances for retirement success. Previous Vanguard research found that participants enrolled in a plan with automatic enrollment and automatic annual increases save, on average, 20% to 30% more after three years than participants in an automatic enrollment plan that doesn’t automatically enroll participants with annual increases.² When the increase coincides with an annual pay raise, employees may not notice much difference in their take-home pay.

Figure 3 shows that among automatic enrollment plans, those most likely to enroll employees with automatic annual increases have employee default deferral rates of 3% and 4%. Plans with lower (1% to 2%) and higher defaults (5%, 6%, or more) are less likely to use automatic increases.

Automatic enrollment helps improve participation, but low enrollment default deferral rates, without annual increases, can lead to low saving rates for participants unless they increase their rate. Plans that include an annual automatic increase may increase the cost of employer matching contributions, but they can improve their participants’ retirement readiness by helping them avoid under-saving for retirement.

Plans that enroll employees at higher default deferral rates without automatic annual increases can also cause participants to anchor at lower saving rates, typically in line with the employer match value. In 2023, the average employer match value was 4.6%, and the maximum employee deferral rate to receive the full value of the match was typically 4% to 6%.

To reach a total saving rate of 12% to 15%, many participants need to save above the maximum match level unless their plan offers extraordinarily generous employer contributions. For plans defaulting at higher rates, including an annual increase probably won’t raise the cost of employer contributions if the plans are already defaulting participants at the maximum employer match rate.

Smart plan design features—such as automatic enrollment with automatic increases, high employee deferral rates, and competitive employer matching contributions—can remove barriers to saving for retirement. “These types of features are valuable because they allow inertia to work in the employees’ favor,” says Vanguard’s Jeff Clark, the author of How America Saves 2024. “When employees are automatically enrolled into a plan with a high deferral rate and automatic increases, they have a better chance of being well on their way to retirement readiness.”

Note:

• All investing is subject to risk, including the possible loss of the money you invest.