(Reuters) — So much for the notion that workers will drop out of their workplace retirement savings plan if employers automatically enrol them at aggressive contribution rates.
That's been the often-heard excuse for auto-enrolment rates in 401(k) plans averaging three per cent. But a study recently released by New York Life Retirement Plan Services found that workers in plans with higher default initial contribution rates are more likely to stay in their plans, increase their contribution rate and personally manage their investment choices.
Plans with less than four per cent default rates experienced a 14 per cent opt-out rate, compared with 10 per cent for plans with greater than three per cent default deferrals, the study said.
Automatic enrolment has exploded since the passage of the Pension Protection Act of 2006, which contained provisions aimed at boosting participation rates. It's having a positive impact. A record 76 per cent of United States workers participated in a defined contribution plan during 2011, according to a new report recently released by Aon Hewitt.
Retirement readiness also is improving, Aon Hewitt found. The study projects that the average worker will need 11 times his final pay in retirement resources; average workers are on track to accumulate 8.8 times final pay, leaving a shortfall of 2.2 times pay. Still, that was a small improvement compared with 2010, when the shortfall was 2.4 times pay.
But low default initial contribution rates are a persistent problem. Sixty-six per cent of workplace plans with automatic enrolment set a default contribution rate of three per cent or less, according to Aon Hewitt. Employers know there's a problem here: 70 per cent of plan sponsors recommend that workers contribute at least nine per cent of income.
Why the gap?
One reason may be employer caution, said David Castellani, CEO of New York Life Retirement Plan Services. "In the early days of default enrolment, there has been some timidity — plan sponsors decided to start off with lower numbers," he said.
But a more important factor is the increased cost of employer matches that accompanies higher worker contributions, said Robyn Credico, leader of the defined contribution practice at Towers Watson, the benefits consulting firm.
"The only reason not to default new workers in at a higher rate is cost," she said. "The data we see suggests that whether you default employees in at three or six per cent the opt-out rate is about the same — they are being passive, so it doesn't matter that much."
Indeed, Aon Hewitt research found that nearly two-thirds of plan sponsors acknowledge that the initial default contribution rate under automatic enrolment is too low to capture the entire employer match. That means many defaulted employees miss out on some of those available dollars. Aon Hewitt found that 63 per cent of defaulted workers had contribution rates too low to capture the full match.
Employers show less resistance to adding auto-escalation features, which boost contribution rates annually, most often by one per cent. "It takes longer to get there, but it does give employers a way to incentivize people to save more," Credico said.
Ninety per cent of auto-enrolled employees are defaulted into target date funds, according to Vanguard Group; these funds set and adjust equity and fixed-income allocations by participant age.
"You can always tell when a company is using auto-enrolment, because everyone in the plan has the same contribution rate and they all are in target date funds," said Credico. "People are defaulting because they are passive about this. So for employers who can afford it, it's their job to come up with the right default rates to improve behavior and outcomes."
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