March 30, 2011

Auto-Enrollment in Retirement Plans Increases Participation, but May Limit Savings

Low default rates could be creating a false sense of security among participants with automatic enrollment

A survey released March 11 by the Defined Contribution Institutional Investment Association found auto-enrollment programs increased enrollment by almost 30%, and sponsors generally have a favorable view of automatic enrollment.

There's another side to that coin, though. While enrollment has increased, participants aren't saving enough. Sponsors indicate they believe the optimal savings rate is around 10%, but the current automatic default rate is typically 3%; if escalation is offered – and only about one-third of sponsors do – that rate rises to just 6%.

While almost half of defined-contribution plans automatically enroll employees in the plan, most plans only offer it to new hires (although more than one-third have done a one-time sweep to include their existing employees). The report notes that by focusing on new hires, it could take "years before the full impact of automatic enrollment" is realized.

The report calls inertia the "friend and foe" of automatic enrollment. Automatically enrolled participants will likely maintain low default deferral levels, and consequently will be stuck with inadequate savings levels for years. On the other hand, because employees favor target-date funds their "savings will be well diversified and strategically rebalanced."

The survey argues that inertia isn't the only factor responsible for high participation rates. Employees like automatic enrollment; at worst, they're indifferent. Over two-thirds of respondents said their employee have a favorable view of automatic enrollment. Zero percent said their employees had an unfavorable view.

Despite generally favorable views of automatic enrollment, two-thirds of sponsors who don't already offer the feature have no plans to do so in the next year, their reason being that participation is already high. Nineteen percent feel automatic enrollment is "too paternalistic," and 18% say it's inappropriate in this economy or a company match would make it too expensive.

The 2006 Pension Protection Act affected plan sponsors largely by leading them to change their default funds. Just 7% changed the default contribution rate, but 41% made no change at all.

Automatic escalation appears to be employers' attempt to save employees from their own apathy. Sixty-eight percent said they offer automatic escalation because they're concerned about their employees having sufficient retirement savings, and 63% offer it because they're worried employees won't take that step on their own.

While automatic enrollment is seen in a largely positive light, employees are mostly indifferent about automatic escalation. As such, most sponsors increase the deferral rate at 1% per year, and most plans are opt-in: Employees have to choose automatic escalation.

Reprints Discuss this story
This is where the comments go.