Popular Retirement Plan Design Features Drives ‘Dramatic’ Results Among Plan Participants
A new report, “Automated Enrollment: The Power Of The Default,” released by researchers with investment management company The Vanguard Group, revealed employers who utilize automatic enrollment features are likely to see participation rates triple to around 91 percent among new hires, compared to the 28 percent participation rates reported by companies without automatic enrollment features. Moreover, the study revealed that automatic features may also increase the likelihood of deferral rate increases as well as default investment fund retention among participants.
In fact, here at Rea & Associates, we became advocates of automatic enrollment and escalation features about 6 years ago when we embraced these options in our own plan design. Even before turning the automatic features on, our plan enjoyed a healthy average deferral rate of 5-6 percent. Today, that percentage rate has increased to 10 percent.
Going back to the study, researchers reviewed 520 retirement plans and 813,918 new hires that were eligible to participate in company retirement plans between Jan. 1, 2017, and Dec. 31, 2019, and who remained employed by the plan sponsor as of June 30, 2020.
Introducing new hires to retirement plan participation, particularly those who are new to the workforce in general and are likely to hold lower-income positions, were most inclined to have dramatically higher plan participation rates. The authors of the study point to the opportunity employers have to inform new employees of the company’s retirement plan and the options that are available to participants, as this is likely the first time new participants will hear of this employee benefit.
In an analysis by the American Society of Pension Professionals & Actuaries (ASPPA), the impact automatic enrollment has on plan participation is clear:
“Consider that even those earning less than $15,000 had a participation rate of 82% under automatic enrollment versus 4% under voluntary enrollment. Similarly, 9 of every 19 employees younger than 25 were plan participants under automatic enrollment, compared with fewer than 2 in 10 under voluntary enrolment.”
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Automatic Enrollment: Is There A Deferral Rate ‘Sweet Spot’?
Over the years, plan fiduciaries have sought to increase default deferral rates from 3 percent, which is traditionally considered a low enough rate to discourage plan participants from opting out. In doing so, companies would play a greater role in their employee’s ability to save for retirement. Fortunately, the study’s researchers found that deferral rates greater than the traditional 3 percent starting point are not likely to sway an employee’s decision for or against participation in the plan. The study actually found that a sponsor’s plan could offer initial deferral rates anywhere between 2 percent to 6 percent and the participation rate among employees automatically enrolled in the plan with income between $15,000 and $29,999 would still come in at around 85 percent. This is great news for employers that have been considering whether to increase their default deferral rates to get plan participants to where they need to be when the time comes for them to retire from the workforce.
Again, going back to our experience with the Rea & Associates plan, our initial automatic deferral rate was set at 3 percent. It wasn’t long before we increased the automatic deferral rate to 6 percent and we are happy to report that we did so without any negative reactions from our employees.
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How To Encourage Participants To Save More?
Meanwhile, while effectiveness of retirement plans without an automatic enrollment feature continued to fall short of plans designed to increase participant deferral rates at regular intervals, even the 37 percent of voluntary participants remaining in the plan after three years were likely to put aside a greater portion of their paychecks into the plan. According to the study, one-third of plan participants chose to override default rates set by the plan sponsor and increasing them. Additionally, another quarter of plan participants not only chose to override and raise their default rate, they opted in to a deferral rate increase. Collectively, of the 37 percent of participants remaining in plans without automatic enrollment after three years, more than nine out of every 10 participants remained in the plan at (or above) the initial default deferral rate.
That being said, as you would expect, after three years of enrollment in a plan designed with automatic increases, about half of the participants remained in the original automatic plan design. Of those, 17 percent opted to increase their contribution rate while continuing to take advantage of the automatic increase feature; and about a quarter of participants dropped the automatic increase feature, but boosted their overall plan contributions. Ultimately, nine out of every 10 participants enjoyed deferral rates above the default deferral rates initially outlined in the design.
Here at Rea, our automatic increase provision is 1 percent and up to 10 percent. To encourage greater retirement savings behavior among our team members, we time automatic increases to be concurrent with annual employee raises. This way, the increased deferral is less noticeable as a reduction of take-home pay. This approach has proven to be incredibly successful.
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Do Participants Want More Say In How Their Contributions Are Invested?
Participants of automatic enrollment plans, according to the study, are about 30 percent more likely to remain in the default option originally designed by the plan sponsor, and 86 percent of these participants will stay 100 percent invested in this default option, compared with only 66 percent of their voluntarily enrolled counterparts. Clearly, plan participants are more comfortable with letting sponsors of their retirement plan allocate their investments and trust that their funds are safe and will provide an ideal return. Even after three years, around eight plan participants of every 10 continued to direct their entire contribution amount to the company’s default investment option and 17 percent are continuing to take advantage of the default investment option in combination with other plan investment options.
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Will Participants Use Retirement Plans As A Short-Term Financial Safety Net?
Finally, the study’s authors considered whether the automatic enrollment feature would influence whether a plan participant would take a loan from their plan to cover short-term financial hardships. Specifically, they wanted to address the concern that automatically enrollees are likely to have higher levels of short-term debt since they are also more likely to save for retirement at higher levels. According to the ASPPA analysis, “while within the time period in question AE participants were found to be slightly more likely to have a loan outstanding (24% versus 20% of those who voluntarily enrolled in the plan), overall, roughly three-quarters of participants do not borrow from their accounts during this period, regardless of plan design.”
Are Retirement Plans With Automatic Enrollment Features Better Then Voluntary Plans?
This study does a great job articulating how retirement plans designed with automatic enrollment features can maximize plan participation while increasing the overall retirement savings of plan participants. Plus, it appears as though Vanguard researchers may have debunked a few retirement plan design myths along the way. For example, some in the retirement plan design community theorized that those automatically enrolled in a company’s retirement plan at a low default deferral rate would be less likely to increase their plan contributions over time when compared to those who voluntarily opted into a plan. While this particular theory appears to hold water in the short-term, this was certainly not what occurred among the long-term plan participants who were surveyed for this study. The original theory further deteriorates when employees who chose not to voluntarily participate in the plan were excluded from the calculation. In doing so, researchers noted that voluntary enrollment “yields much lower contribution rates than automatic enrollment – 1.9% versus 5.8% over the three-year period.”
If you would like to learn more about the benefits of designing a retirement plan with automatic enrollment and automatic escalation features, contact the retirement plan design and administration services team at Rea & Associates. Or, click here to learn more about the retirement plan services the firm officers.
By Steve Renner, QKA (New Philadelphia CPA Firm)
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