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401k Automatic Enrollment

Does 401(k) Automatic Enrollment Really Benefit Savings?

Many 401(k) experts were upset by a recent article published in the Wall Street Journal. The article suggested that enrolled individuals automatically faced a decrease instead of increase in retirement savings rates. To clarify the point, the article's author wrote that this is because most participants don't change their contribution rate from the default level. The default rate is lower than the contribution rate most people choose with active enrollment. This question was added to provide a thought: What should 401(k) sponsors do when they start offering plans featuring a default contribution percentage for automatic enrollment? Although most people wouldn't deny the importance of enrolling in one of these plans, it is clear that workers need to save more money for retirement.

Escalation Rates

The design of plan features is being blamed more frequently for the problem relating to low contributions after automatic enrollment. A survey conducted by Vanguard Investments showed that the most popular default contribution for automatic enrollment plans was 3% of total pay. Nearly 58% of the plans surveyed used this percentage rate. This survey studied over 2,000 contribution plans.

The same survey also showed that 73% of plans use a 3% default contribution. However, only 27% chose a default rate of 4% or higher. One of the most intriguing pieces of information in this study was that the 3% rate seems to be chosen simply because the IRS used it as an example in its governing regulations for these types of plans. Whether or not this is every party's reason for choosing the 3% default rate, financial planners definitely agree that this percentage is inadequate for a secure retirement. Jean Young, a Senior Research Analyst for Vanguard's Center for Retirement, said that the majority of their plans use a default rate between 1% and 3%. She said this shows that most plans would benefit from a higher default rate.

To remedy this matter, most employers begin an automatic escalation feature. This increases the contribution percentage from each participant who automatically contributes to the plan at specific times. The same Vanguard study showed that most large companies have an automatic escalation feature. For example, a plan that has a low default rate may add an automatic increase of up to two percentage points annually until all contributors reach a cap amount or percentage of pay.

However, there is significant proof that the default plans are not sufficient to secure retirement. This is also true of plans that include an escalation provision. Vanguard's research shows that employees need contributions that total between 12% and 15% of pay each year. In summary, employers usually set default contribution rates too low and provide insufficient escalation rates. The combination of these factors show that many participants likely won't have the amount of money they should when they retire.
 
Further Contribution Rate Issues

In a different research study, Vanguard surveyed overall contribution levels to see if they were sufficient for retirement needs. At least 40% of the plans they studied had inadequate rates. Participants in the study had overall contributions, which included those from the employer and themselves, of less than 9% of total pay. Young suggests that sponsors should set higher default and escalation rates. She suggests a default rate of 6% in conjunction with an annual escalation rate of two percentage points. This remedy brings the savings rate higher than 12% within three years.
 
Continuing Education

While remedying the situation of insufficient contribution rates is essential, it's also important for 401(k) plan sponsors to stay current with communication and education programs. Knowledge is the key to preventing such problems. To gain that knowledge, sponsors need to be thoroughly educated and have a firm understanding. For example, obtaining adequate training gives sponsors enough knowledge to understand why a default rate of 3% will not work. By learning how to analyze gaps over time, sponsors who receive continuous training are able to make changes that benefit participants in the future.
 
Matching Contributions

One of the most vital ways plan sponsors can help employees is to match contributions. During the recession, many sponsors eliminated or greatly reduced their matching contributions. In addition to having an adverse effect on participant savings rates, this reduction also hurt overall participation levels. When companies imposed this reduction, there was a significant decline in participation. Smaller companies avoided automatic plan features, such as contribution escalation and automatic enrollment. Experts believe that, due to their personalized approach toward benefits and interaction, small companies don't require automatic features.
To put the entirety of this information into perspective, it's important for sponsors to recognize issues and have the knowledge to properly correct them. They must also understand engagement and behavior of both types of enrolled participants.