Vanguard recently took a look at automatic enrollment as it relates to “stickiness” of plan participants and investment. No surprise—the defaults in plan design are quite sticky.
“Among new hires, participation rates more than double to 91% under automatic enrollment, compared to just 42% for plans with voluntary enrollment,” writes Jean Young, a senior research analyst with Vanguard Center for Retirement Research. “Over time, eight in ten participants increase contribution rates either automatically or on their own. In addition, seven in ten participants remain exclusively invested in the default fund (and another 15% are contributing some money to the default fund). Design is powerful—defaults are sticky!”
But she was struck by a couple of findings. For one, half of the plans still default participants at 3% of their pay.
“Plan sponsors tell us they are worried that a higher automatic enrollment default deferral rate might lead to more individuals opting out of their plans,” she adds. “Is this what happens? In a nutshell—no.”
Intuitively, we might expect that plans with lower initial contribution rates of 2% or 3% would be less likely to have employees quit their plans because 2% or 3% contributions have little impact on take-home pay, she explains. Conversely, we might think that contribution rates of 5% or 6% would lead to higher opt-out rates because of their larger impact.
“We found that employee quit rates do not appear to vary in response to a plan sponsor’s choice of the initial contribution rate. The participation rate among all employees is about 90%—regardless of whether the initial contribution rate is 2% or 6%—and the participation rate among employees earning less than $30,000 is about 80%.”
Most of the plans pair automatic annual increases with automatic enrollment. But two in 10 plans cap their annual increases at 6% or less. Most participants are going to need higher saving rates to achieve retirement security. These plan sponsors should consider setting the cap higher for annual increases—at say 10% (which is the most common cap seen).
“Sponsors can improve retirement outcomes for their employees by adopting automatic enrollment with higher initial contribution rates paired with automatic annual increases with a total participant contribution cap of at least 10%,” Young concludes. “A best practice: default employees at the level where the employer match is maximized and increase the deferral rate until individuals are saving at least 10% of their pay.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
