The shift from defined benefit (DB) plans to defined contribution (DC) plans has left many Americans with the possibility of having unanchored retirements. The transition to contributing to and planning for one’s retirement has not been easy, resulting in inadequate retirement plans, even by diligent savers with the best intentions and woefully underfunded plans by those who take a lax approach to planning.
In order to ameliorate the underfunded retirement crisis brewing in America, automatic-enrollment (auto-enrollment) began to gain steam in the late 1990s. The trend, which was then bolstered by the Pension Protection Act of 2006, automatically enrolls employees in 401(K) plans forcing them to actively opt out rather than actively opt in.
Recently, the Center for Retirement Research (CRR) at Boston College concluded that although auto enrollment polices may boost the retirement savings of workers that would have never contributed at all, they could hinder the savings of those who would have been conscientious contributors due to low employer match rates and low default contribution rates.
The study, which utilized 2010/2011 restricted data from the National Compensation Survey (NCS) conducted by the U.S. Bureau of Labor Statistics, sought to examine how employer behavior under auto enrollment impacted employees’ retirement savings.
The CRR found through the samples attained, that auto-enrollment plans do in fact foster higher participation rates. Auto-enrollment plan participation rates were a full 10 points higher than plans without them — 77 percent to 67 percent.
Because most employers match a certain percentage of their employees’ contributions, with all things equal, higher enrollment activity would translate to higher total compensation costs for employers. It is the methods in which employers apply to mitigate and alleviate these higher costs that can in turn impact the health of their employees’ plans.
The CRR endeavored to examine the theory which held that employers with auto-enrollment programs offer lower maximum matching contributions than employers who do not utilize auto-enrollment. The maximum match rate for workers in auto-enrollment plans was 3.2 percent while employees not enrolled was 3.5 percent.
According to the CRR, the seemingly small difference is statistically significant however, they caution that the difference in match rates may be due to other factors. They noted that a large percentage of workers covered by auto-enrollment in the sample were having their DC plans buttressed by DB plans. Since they have more than one retirement savings vehicle provided to the employee, employers may lower the percentage they match. A regression analysis conducted seems to uphold the theory.
The CRR also sought to find out whether employers who offer auto-enrollment choose lower default employee contribution rates in order to keep their match commensurately low. This practice could be particularly harmful to employees’ retirement health as it has been proven that many take a “set it and forget it” approach, assuming that their employers would enroll them at a rate sufficient to yield substantial retirement income and not actively managing their account.
CRRs data found that overall, employers with auto-enrollment may be using their default employee contribution rate to help them offset the higher costs that accompany the higher rates that accompany auto-enrollment. It should be noted that some auto-enrollment plans feature “auto-escalation” features that increase the default rate over time. These plans were included in their sample.
Finally the CRR examined the relationship between auto-enrollment plans and overall compensation. They concluded that the idea that employers who offered auto-enrollment plans could possibly be striving to keep their compensation costs a constant. However, they end up spending more on workers that would have avoided participation and less on workers that would have participated anyway.
The CRR concluded that employer decisions regarding 401(k) plan designs have huge impact on how much workers save for retirement. They caution that although auto-enrollment plans are undoubtedly successful at raising participation rates, they may not boost overall savings due to the aforementioned reasons. However, the trend of auto-enrollment policies are fairly new and further observation is needed to arrive at conclusive detail their impact on employees’ retirement health.