Add this to the ever-growing mountain of evidence that automatic enrollment in 401k plans combined with automatic escalation creates better participation and savings outcomes.
A recent T-Rowe Price white paper found that automatic enrollment almost doubles plan participation and successfully gets participants who might not have otherwise saved saving, and for retirement plan participants to fully benefit from automatic 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.
The paper, “Automatic Enrollment’s Long‐Term Effect on Retirement Saving,” was authored by T. Rowe Price Associates Vice President and the head of Retirement Thought Leadership Joshua Dietch and Taha Choukhmane, Ph.D., assistant professor of finance at MIT Sloan School of Management.
In the 15 years following the enactment of the Pension Protection Act (PPA) in 2006 (a catalyst for auto enrollment), the paper says the number of T. Rowe Price clients who implemented automatic enrollment almost doubled from 37% to 74%.
When the PPA was enacted, the most common default rate was 3%, and 61% of T. Rowe Price’s clients who implemented automatic enrollment chose that as their default (likely influenced by Internal Revenue Service rulings approving of automatic enrollment arrangements using a 3% default as an example). That number had fallen to 31% by 2018, as the percentage of clients who are setting their default deferral policy rate to at least 6% has grown from 4% to 36%—a likely result of some plan sponsors availing themselves to the QACA safe harbor and others simply adopting 6% as a perceived best practice.
Automatic enrollment is clearly an effective means of increasing plan participation, as evidenced by the fact that plan participation for T. Rowe Price‐recordkept plans that have adopted automatic enrollment is 85% compared with just 39% for those who had not implemented it.
Digging deeper into the paper’s insights, analysis from the authors found that both younger and lower‐paid workers can benefit from defaults in general, and from investing in a target date portfolio in particular. Workers who invested in a target date portfolio could accumulate as much as 41% more in lifetime wealth compared with those who had to proactively opt in to participate in their employer’s plan.
For higher‐wage earners, the benefit of automatic enrollment is less significant because those who can afford to save more in the future do. Further, behavioral finance research has shown that high‐wage earners may undersave as a negative, yet unintended, consequence of the framing or endorsement resulting from the default rate.
The full paper is available here.
SEE ALSO:
• Further Proof that Auto-Enrollment is Key to Saving Earlier for Retirement
• Most Common 401k Default Deferral Rate No Longer 3%—It’s Better!
• Average 401k Balances at T. Rowe Price Rose 8% in 2021