Proponents of automatic features for retirement plans have long argued that they increase participation and savings rates, and a recent study joins others in suggesting they’re onto something.
“Automatic enrollment in employer-sponsored 401(k) savings plans has transformed the way millions of Americans save for retirement,” said Joshua Dietch, head of T. Rowe Price Retirement Thought Leadership, and Taha Choukhmane, Ph.D. MIT Sloan School of Management Associate Professor of Finance in his report, “The long-term effect of auto-enrollment on retirement savings.”
Set the table
According to Dietch and Choukhmane, more 401(k) plans offer automatic enrollment as well as higher default deferral rates for employees, and it’s been around longer than many realize. They note that while many believe the Pension Protection Act of 2006 (PPA) was the catalyst for auto features, the IRS actually paved the way in 1998 to Tax Ruling 98-30. The ruling allowed employers to use “negative consent” to automatically enroll employees in the 401(k) they offer, forcing employees to opt out of their choice not to participate.
After the promulgation of the PPA
It may not have been the initial catalyst, but the APP had a significant effect, write Dietch and Choukhmane. They report that the number of plan sponsors who are T. Rowe Price clients and have implemented automatic enrollment has doubled in the 15 years since the PPA’s enactment, from 37% in 2006 to 74%. in 2021. They attribute this to a variety of factors, including:
- federal preemption over state laws that might have prohibited automatic enrollment;
- fiduciary protection for qualified default investment alternatives (QDIA); and
- a new safe harbor for qualified automatic contribution schemes (QACA).
And the prevalence of auto-enrollment isn’t the only one that’s increased, say Dietch and Shukhman. They note that the most common default rate was 3%, which they say was the result of IRS rulings that used 3% as an example default rate. But in 2018, 12 years after the PPA was enacted, the percentage of T. Rowe Price clients who were using 3% while the rate dropped from 61% to 31%; moreover, the percentage of their clients setting the rate at 6% increased from 4% to 36%.
As of December 2018, according to T. Rowe Price Retirement Plan Services, participation in auto-enrollment plans was 85% with an average retention rate of 7.8%; among plans that did not implement auto-enrollment and required employees to enroll, however, uptake was half that of plans with auto-enrollment – 39%.
Effect of automatic registration
In research regarding the effect of automatic enrollment, Shukhman’s findings included the following.
Registration is a learned behavior. Choukhmane says research suggests employees who have been auto-enrolled in the past are less likely to join a new plan with an employer that doesn’t offer auto-enrollment. He adds that the research also suggests that there is a risk that employees who automatically enroll are conditioned to do so, and that if it is not offered by a future employer, they could delay savings opportunities or miss them. completely.
Higher default rates do not significantly harm savings. Research suggests that increasing the default rate won’t lead to a high default rate, Shukhman says. He cites data from T. Rowe Price showing that a 1 percentage point increase in the default rate led to a 1 percentage point decline in participation.
Automatic registration can be a “boost” to save. The report cites previous research by Cass Sunstein and Richard Thaler that indicated that auto-enrollment encourages employees to save, but Choukhmane still argues that auto-enrollment should be “well thought out and useful.”
Particularly pronounced effect on some employees. Choukhmane found that employees earning low wages might not have saved if their employers had not instituted automatic enrollment. Additionally, younger employees could benefit from auto-enrollment by allowing them to compound returns over longer periods of time.
The opt-out is not a disaster for high-income earners. Choukhmane notes that not participating does not necessarily mean that employees with above-median incomes will not save. He found that these employees can “catch up” and that within three years, those who voluntarily opt in to save at levels comparable to those employees who participated in the plan due to automatic enrollment.
Choukhmane suggests that plan sponsors strive to maximize the effectiveness of their retirement plan design and find “an optimal balance” by carefully considering:
- what outcome they desire;
- their budget;
- what they know about employee behavior; and
- what they intend to accomplish through designing a plan.
Behavioral economics, Shukhmane says, “ultimately demonstrates” is that there is no one way to increase plan participation and payroll savings. He argues that the combination of automatic elements – registration, escalation and re-registration – can “lead to optimal results”. And Shukhman also argues that the design of the plan should reflect the fact that an employer’s workforce can include people at different stages of their working lives.