A new study finds workers allocate more to their retirement when offered a higher default savings rate.
The study, “Save more with less: The impact of employer defaults and match rates on retirement saving,” authored by industry leaders David Blanchett, Michael Finke, and Zhikun Liu, surveys nearly 157,000 participants in plans with automatic enrollment and an employer match, and highlights the impact of higher default savings rates and match rates on retirement savings and investment decisions. The study focused on new participants who recently made benefit elections.
“What [this study] lets you do is look at all the different levels of default savings rates and match rates to see which is having a larger effect,” said Blanchett, who is managing director and head of Retirement Research at PGIM, in an interview with 401(k) Specialist. “The result was very clear. While having a match was good, automatic enrollment and having a high default savings rate is much better.”
According to the findings, employees tend to save less when default savings rates are lower (at around 3% to 4%), than when rates are 5% to 6%. The highest percentage of employees holding default investments occurred in plans with a high default savings rate and a low match rate, with the lowest percentage of participants working with a smaller default rate and a shorter match.
Blanchett connects the findings to the conversation around affordability between high-income and lower-income workers. While high-income employees tend to save up to the maximum match, this isn’t always the case with the latter group. Instead, adding a default savings rate puts all workers—no matter what income—at an equal playing field.
“Not only does having a higher default savings rate result in more of an impact on deferral levels than match rates, but it’s also more equal across all participants,” he said. “You don’t just see higher income participants saving more with default savings rates like you did with a match because you don’t have to make an active choice around the benefits of saving. “
Higher savings rates lead to better usage of investments
The study also analyzed the relationship with higher default savings rates and investment factors, finding that implementing the former resulted in better usage of plan default investments such as target-date funds (TDFs). According to the study, the chance of a participant selecting a TDF increased with higher default rates but decreased for higher match levels and match rates.
The study connects this behavior to the relationship between default investments and the savings rates. If the default savings rate is aligned with a participant’s expected savings level, they are more likely to accept the investment.
This therefore suggests that higher default rates can improve participant outcomes in making better investment decisions, the research states.
“At higher default savings rates, this results in higher acceptance of the default investment TDFs because [plan sponsors are] creating a path that is intuitively easy and intuitively optimal,” Blanchett said. “Whatever the employer selects as the match rate or the default savings rate, it has this sort of implicit thinking, where employees go with that because that is what the employer says they should be doing.”
What the study tells us
If the research says anything to retirement plan advisors and their plan sponsor clients, it’s to go big on the default savings rate, emphasized Blanchett. Whereas an employer match has widely been regarded as key to employer-sponsored 401(k) plans, the weight behind the default savings rate can be significant enough for all participants, he added.
“In my opinion, 6% is the absolute minimum default savings rate that should be assumed for a plan. If you’re a plan sponsor that has a match and is worried about a higher savings rate, change your match formula,” he said. “Get people to do more, and you can get them to do that if you have a higher default savings rate.”
SEE ALSO:
- Episode 18—David Blanchett on the Benefit of Downturns and How Target Funds Should Really Be Used
- Episode 26: The American College’s Michael Finke on Why 2021 Will Be an Eventful Year for Retirement Reform
- 401k Participants Largely Pass on ESG Options, Research Finds
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.
