Auto-enrollment almost doubles 401k plan participation, but can also result in participants saving less than those who voluntarily opt in and set their own deferral rate, according to a new white paper from T.Rowe Price.
Plan participation for T. Rowe Price-recordkept plans that have adopted auto-enrollment is 86% compared with just 44% for those who had not implemented it.
However, with the good comes an unintended consequence of lower savings rates, the paper notes: “Those who were not auto-enrolled deferred almost 3% more of their salary on average (9.3%) compared with those who were auto-enrolled (6.5%). This discrepancy suggests that deferral rates set by the employer could result in an endorsement effect. The employee might infer that the default rate is ‘safe’ and may not think of contributing more.”
The paradox of auto-enrollment
Research by Taha Choukhmane, Ph.D., a retirement researcher at the National Bureau of Economic Research (NBER) and MIT Sloan School of Management, sought to determine if automatic enrollment in a 401k plan increases lifetime wealth accumulation and benefits all participants equally. And if so, could that result in plan designs that better reflect the plan sponsor’s desired outcome?
Among the conclusions:
- Enrollment is a learned behavior
The data showed that auto-enrollment and opt-in enrollment are learned behaviors.
Auto-enrollment alone does not create healthy, long-term financial behaviors. In fact, the opposite is true.
The research suggests that employees who have experienced auto-enrollment in the past are less likely to join a new plan where the employer does not offer auto-enrollment. The research also found employees who are auto enrolled run the risk of becoming conditioned to it, and its absence at future employment can result in missed or delayed savings.
For employees to fully benefit from auto-enrollment, it needs to be combined with auto-escalation. That way, employees can enjoy the benefits of compounding rates of return by saving early in their careers and may be able to avoid the need to save more later in order to compensate for missed opportunity.
Though auto-enrollment is framed as a means to increase savings, the reality is that it is a better means to increase participation. And when auto-escalation is omitted, auto-enrollment can actually suppress savings compared with opt-in 401k plans.
- Higher defaults won’t discourage savings
Employers often ask if participants will opt out if the auto-enrollment default rate is raised. The evidence suggests that is not the case.
The analysis of T. Rowe Price’s recordkeeping data looked at the effect of employers raising their defaults above 3% and found there is minimal impact. If the default rate rises by 1%, one could expect the participation rate to fall roughly 1%. Additional increases result in effects of similar magnitude.
A clear majority of participants benefit from greater savings compared with the relative few that opt out.
- 3. Auto-enrollment is a progressive benefit
The primary logic behind auto-enrollment is that it encourages saving through what Cass Sunstein and Nobel prize-winning economist Richard Thaler dub “libertarian paternalism,” in their book “Nudge.”
In other words, auto-enrollment provides a “nudge” toward saving, but the participant is free to save more, less, or the same if they so choose.
Dr. Choukhmane looked at employers who implemented auto-enrollment at 3%, and the behaviors of employees who had been hired in the year prior to the implementation of auto-enrollment and the behavior of new hires post-implementation of auto-enrollment.
What he found was that if not for auto-enrollment, low-wage earners might not otherwise save, and younger employees could potentially enjoy greater benefit from compounding returns over longer periods of time. The 25th percentile (with largely low-paid and younger employees) consists of the primary beneficiaries of auto-enrollment. Without their employer nudging them to save, they don’t.
Looking specifically at workers above the median, the effects of auto-enrollment are not significant. Those who voluntarily opt in save at equivalent levels within 36 months of those who were defaulted into their plans.
Finding an optimal balance
The white paper concludes with the options plan sponsors have at their disposal to maximize the efficiency of their 401k plans, and says an optimal balance between participation rates and deferral rates can be met by carefully considering the outcomes desired, budget parameters, and what is known about employee behavior.
While the research ultimately demonstrates there is no single solution to increase both participation and savings, the right combination of design approaches, such as auto-enrollment, auto-escalation, reenrollment, etc., can lead to optimal results.
Interested people can find more detail in the entire white paper available here.
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
