In 2014, the Bipartisan Policy Center (BPC) launched the Commission on Retirement Security and Personal Savings, led by former Senator Kent Conrad and WL Ross & Co. Vice Chairman Jim Lockhart. The commission will consider and make recommendations regarding Social Security, pensions, defined contribution (DC) savings vehicles, strategies to generate lifetime income and other factors that affect retirement security.
This BPC-staff authored post is the second in a series that will outline the state of retirement in America and provide a sense of the challenges that the commission seeks to address in its 2015 report.
Automatic enrollment is a powerful tool to combat non-participation. Workers in these plans automatically begin contributing to their DC retirement account at the default rate unless they actively choose a different rate (or opt-out completely). The employees’ contributions are invested into a fund chosen by the plan sponsor – usually a target-date fund, which is a mutual fund that automatically adjusts toward more conservative investments as the owner approaches retirement age.1
In Vanguard’s 2014 report, How America Saves, 58 percent of individuals were in plans that featured automatic enrollment. At this point, while over half of large employers offer automatic enrollment, only between one-quarter to one-third of smaller plans (under 1,000 employees) do so.
Once workers are enrolled in a plan, automatic escalation is a design feature that can be used to increase their contribution rates. Under an automatic-escalation plan, workers’ contributions are increased by a set amount every year (usually 1 percent of pay) until they reach a particular cap (usually either 6 or 10 percent of pay). Vanguard’s latest report found that 69 percent of Vanguard plans that offered automatic enrollment also offered automatic escalation.
Broader Adoption of Automatic Enrollment: Wider implementation of automatic enrollment would probably increase plan participation. A 2006 study of several different companies found that participation rates for employees who had been working for one year rose to 85 percent following the adoption of automatic enrollment (compared to less than 50 percent prior to adoption).
Default Contribution Rates: The default rates that plan sponsors select tend to be very “sticky” (i.e., employees tend to remain at those rates), and many plan sponsors have historically chosen rates that are below what financial planners would recommend. Two-thirds of plans that have implemented automatic enrollment have selected a default contribution rate of 3 percent or below, with the majority of plans at exactly 3 percent.2 These low default contribution rates may be influenced by the current safe-harbor design for automatic-enrollment plans. Plan sponsors can avoid certain administrative requirements if they use the automatic enrollment safe-harbor design, which requires employers to automatically enroll individuals at a rate no lower than 3 percent of pay in their first year and no higher than 10 percent of pay.3
There is evidence that plan sponsors could choose higher default contribution rates without losing plan participants. Fidelity found that the number of individuals who stayed with or contributed more than the default rate only decreased modestly (with estimates ranging from 5 to 16 percent) when the default contribution rate rose from 3 to 6 percent. This suggests that higher default savings rates would spur more overall savings in DC retirement plans.
Automatic Escalation: While automatic enrollment and investment into target-date funds have penetrated the retirement market, implementation of automatic escalation has not been as widespread. The recent Vanguard report found that 31 percent of Vanguard plans that offer automatic enrollment do not automatically escalate plan members. Making automatic escalation more prevalent as a default feature would result in more workers taking advantage of that option and would likely increase overall savings.4
Orphaned Accounts: Enacting automatic enrollment can increase the chance that workers will not bother to opt-out and will then be unwilling to deal with the hassle of rolling their account over when they leave their employer. Many lower-income and younger workers with smaller balances may decide that rolling over an account when they leave is not worth their while. Making the rollover process easier could substantially alleviate this drawback of automatic enrollment.
The Bottom Line
By offering auto-enrollment, higher default contribution rates, and/or auto-escalation, employers can help their employees save more and better prepare for retirement. While a little more than half of workers are already in plans with automatic enrollment, adoption is substantially higher in large plans than in small ones. Due to the significant influence that plan defaults have on employees’ retirement savings, BPC’s commission plans to examine this and other associated challenges with plan design.
Alex Gold contributed to this post.
View all posts in BPC’s Retirement in America series under Related Stories below.
1 For younger participants, a typical target-date fund is mostly invested in equities; by retirement age, the funds are mostly composed of bonds and money-market instruments. There is wide variation among target-date funds in investment style (active management versus indexing) and fee levels.
2 See Vanguard’s 2014 How America Saves report.
3 Plans that implement the automatic enrollment safe harbor are exempt from conducting annual antidiscrimination tests, which are designed to ensure that plan benefits are not overwhelmingly accruing to highly compensated employees. While many plans that are not technically part of this safe harbor have implemented automatic enrollment, the safe-harbor design features may have also influenced these plan sponsors in selecting relatively low default contribution rates.
4 Many employees do not remain with an individual employer long enough to reap the benefits of automatic escalation, so in practice, it may be less important than encouraging higher default contribution rates under automatic enrollment.