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How 401(k) Plans Have Changed Over the Past Decade

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Financial advisors working in the 401(k) market or planning to should get a copy of Vanguard’s “How America Saves 2017” report on the 401(k) plans it manages, which highlights the latest trends in that market from one of its largest recordkeepers. 

(Related: $4.7 Trillion 401(k) Market ‘There for the Taking’ for RIAs)

Vanguard services more than 8,500 401(k) plans, with 4.6 million-plus participants and more than $1 trillion in total assets. Its latest report is based on data from 1,900 qualified defined contribution plans with 4.4 million participants, and subsets of that data. Ninety percent of the plans are 401(k) or 403(b) plans; the other 10% are employer contributory plans such as a profit sharing or money purchase plans.

(Related: 30 Best Large 401(k) Plans in 2016: BrightScope)

Here are some of the fastest growing trends the report reveals:

Increasing Use of Automatic Enrollment

The number of plans that automatically enroll employees grew 300% since 2007.

Forty-five percent of plans use automatic enrollment, but because larger plans are more likely to do so, that covers 60% of participants compared with just 17% at the end of 2007. By 2021, Vanguard expects three-quarters of participants will be covered by a plan using automatic enrollment.

“Automatic enrollment or autopilot plan design has reframed the savings decision,” according to the report. Under auto-enrollment, employees no longer have to choose to enroll in a 401(k) since that decision is already made for them, but they can choose not to participate.

About two-thirds of plans using auto-enrollment have also eliminated the need for employees to increase their contribution rates because that, too, is automatic. The most popular deferral rate for auto enrollment plans is 3%, accounting for 44% of those plans; 20% have a default deferral rate of 6% or more.

Rising Participation Rates

The growing use of auto-enrollment plans has led to greater participation among employees.

An estimated 81% are enrolled in defined contribution plans compared to 76% at year-end 2007 and the participation rate among plans with automatic enrollment is even higher — 90% compared with just 63% of plans using voluntary enrollment.

Ironically, while participation rates have increased among employees because of auto-enrollment, contribution rates have fallen, for the same reason. Participants saved an average 6.2% of their income in 2016, and a median 5% — both lower than those respective rates for every year since 2007.

The Vanguard report explains that automatic enrollment “leads to lower contribution rates when default deferral rates are set at low levels, such as 3% or lower,” and close to half the plans using automatic enrollment use a 3% contribution rate. The other half uses a rate of 4% or more, including 20% set at 6% or higher.

Participation rates, not surprisingly, are highest for those earning the most income — 93% of employees earning more than $100,000 — and lowest among those with the least income — 65% among those earning less than $30,000, but still nothing to scoff at.

About two-thirds of auto-enrollment plans have implemented accelerated annual contribution rates, with 4% deferral being the most popular, accounting for 48% of plans compared with 24% in 2007. For 20% of plans, the default contribute rate is 6% or more — nearly triple the share of plans in 2007.

As a result, slightly more than 6 in 10 participants are now in plans with autopilot designs, although automatic enrollment itself may only apply to newly eligible participants.

Growing Use of Target Date Funds

The growing use of automatically enrollment has also led to increasing investment in target date funds (TDFs), which are the favored default investment for plans that automatically enroll employees. 

Nine out of 10 plan sponsors offered TDFs by year-end 2016, up from over 50% at year end 2007, and almost three-quarters of participants  were invested in target-date funds, many (46%) in a single TDF.

Target date funds account for almost half of all 401(k) assets serviced by Vanguard.

In addition to the benefit of linking investments to age of participants – reducing risk as savers grow older and get nearer to retirement – these funds also eliminate what Vanguard calls “extreme equity allocations,” holding too few equities or too many. By year-end 2016, the fraction of participants with no allocation to equities fell to 4% from 11% in 2007 and those with only equities fell to 6% from 17%.

Increasing Eligibility for Employee Participation

Approximately two-thirds of plans allow employees to participate as soon as they begin their job, up from just 50% in 2007. Again because larger plans are more likely to offer immediate eligibility at hire, 77% of participants had access to immediate enrollments at year-end 2016 compared to just 63% at year-end 2007.

Only 11% of plans require one year of employment before participating. Also, 45% of plans allow immediate vesting of employer matching contributions while one-third require five or six years for full vesting and 20% longer than that.

Matching Employer Rates

Unlike automatic investing, employer contribution matches to plans were little changed in 2016 compared with 2007 in part because matches contracted or were withdrawn during the financial crisis.

While 82% of plans match employee deferrals, including about half who also offer additional employer contributions, the average match is currently 4.1% to 4.2% in 2007 though the median was 4% versus 2%.

The most popular match by year-end 2016 (70% of plans) was 50 cents on the dollar, up to 6% of pay, for a maximum match of 3% of salary, followed by a match of $1 to $1 of pay plus 50% of the next 2%, for a maximum match of 4% (22% of plans).

Profile of Vanguard-Managed 401(k) Plans

By year-end 2016, the average account balance for participants averaged $96,495, little changed compared to 2015; and the median account was $24,713, 6% lower than in 2015.

Vanguard attributes this lackluster change to two factors: a changing business mix — new plans converting to Vanguard in 2016 had lower account balances — and the rising adoption of automatic enrollment, which results in more individuals saving as well as a growing number of smaller balances in accounts.

Over the five years ended Dec. 31, 2016, however, the average account balance of employees who continuously participated in a Vanguard plan more than doubled (up 121%), due to ongoing contributions and strong market returns. Their total returns averaged 9.1% gain per year.

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