If anyone needed another example of the effectiveness of automatic enrollment, here you go…
Automatic enrollment triples—yes, triples—the 401k plan participation rate among new hires according to some recently updated research from Vanguard.
The research, “Automatic enrollment: the power of the default,” shows default decisions made by defined contribution (DC) plan sponsors under automatic enrollment indeed have a powerful influence on participant saving and investment behavior.
Among new hires, participation rates triple to 91% under automatic enrollment, compared with 28% under voluntary enrollment. After three years, participation in plans with auto enrollment remained high, with 92% of participants hired under automatic enrollment still participating vs. 29% of participants under voluntary enrollment.
Over time, nine in 10 participants increase their deferral rates, either automatically or on their own, and more than three-quarters of participants remain exclusively invested in the default investment fund.
Data updated since Vanguard’s 2018 report are drawn from Vanguard recordkeeping data on the effects of automatic enrollment on participants’ saving and investing behaviors. The study is based on 813,918 newly hired eligible employees in 520 plans.
Plan sponsors can use the inertia inherent in participant retirement savings decisions to improve retirement outcomes in DC plans. Strategies include increasing minimum default deferral rates, including an automatic increase feature with a cap of at least 10%, and periodically “sweeping” eligible nonparticipants into the default design.
More findings from the new research:
- Employees earning less than $15,000 had a participation rate of 82% under automatic enrollment vs. 4% under voluntary enrollment. Similarly, nine of every 10 employees younger than 25 were plan participants under automatic enrollment, vs. fewer than two in 10 under voluntary enrollment.
- Results suggest that employee quit rates do not appear to vary in response to a plan sponsor’s choice of the initial deferral rate. The participation rate among employees earning $15,000–$29,999 is around 85%—regardless of whether the initial deferral rate is 2% or 6%.
Among all eligible employees, automatic enrollment plus an automatic increase feature generally lead to higher employee contributions over time. While the average participant contribution rate for new hires in voluntary plans is slightly higher, at 7.0%, than the 6.4% rate for those in automatic enrollment plans, as plan sponsors adopt stronger defaults, these rates have begun to converge.
Additionally, when calculating in the entire employee population—which includes both plan participants and nonparticipants, who contribute at 0%, voluntary enrollment yields much lower contribution rates than automatic enrollment—1.9% vs. 5.8% over the three-year period.
Default investment options ‘sticky’
The study also examined the impact of automatic enrollment on investment behavior. Averaged over the entire study period, participants in automatic enrollment plans are about 30% more likely to remain in the default investment option designated by the employer—86% of participants under automatic enrollment remain 100% invested in the default option, vs. 66% of participants under voluntary enrollment who happen to have chosen to invest their entire account in the designated default.
The effects are sticky over time. After three years, about eight in 10 participants are still directing 100% of their contributions to the default investment option, and another 17% are using the default investment in combination with other plan investment options.
Loan activity
Over the time period observed in the study, auto-enrolled participants were slightly more likely to have a loan outstanding than voluntarily enrolled participants. For example, after three years, 24% of auto-enrolled participants have loans vs. 20% of voluntarily enrolled participants (a 17% relative difference).
The amounts borrowed by auto-enrolled participants follow a similar pattern. Overall, roughly three-quarters of participants do not borrow from their accounts during this period, regardless of plan design.
Although the fraction of automatic enrollment participants with a loan is higher, it is important to keep in mind that automatic enrollment triples the participation rate compared with eligible employees in plans with voluntary enrollment designs. So while there are more participants with loans, there are still more eligible employees participating without a loan under automatic enrollment than in plans with voluntary enrollment designs, the research states.
Conclusions
Being a pivotal, proven strategy to improve plan participation and savings rates in 401ks, automatic enrollment combined with higher initial deferral rates and auto escalation will help plan sponsors improve retirement outcomes.
“Stronger default designs will help improve retirement outcomes because of the effect of inertia,” the Vanguard study concludes. “Sponsors should seek to take advantage of this behavioral bias when designing their DC retirement programs.”
A brief of the findings is available here, and the full research is available here.
SEE ALSO:
- 7 Changes to 401k Plan Design Driven by Behavioral Finance
- Auto-Enrollment, TDFs Continue DC Plan Domination
- Automatic for the People: Workers Want “Extreme” 401k Plans
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.
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