When a Downward Trend in the Average Deferral Rate Is a Good Thing

A new defined contribution (DC) plan industry assessment, conducted by BMO Global Asset Management, seeks to provide financial advisers and retirement plan sponsors with an overview of the forces shaping their daily efforts to provide high-quality retirement benefits. 

The guide, “DC Conversations: An industry assessment of Defined Contribution Plans,” presents an extensive amount of data largely without commentary, allowing readers to draw their own conclusions directly from the survey responses. Asked to highlight what he sees as the most important data points, Chris Barlow, national director of defined contribution investments, points to a downward trend in deferral rates measured since 2010. According to the BMO data, deferral rates are down 1.7% across all sectors since 2010.

Barlow makes an important distinction about this figure by noting that automatic enrollment usage continues to increase pretty dramatically—up 36% in the last 10 years. Early adopters of automatic enrollment traditionally used a 2% or 3% default deferral, he observes, and automatic escalation remains less common. As a result, while more people than ever are saving within defined contribution plans, the top-line average deferral rate has in fact fallen. Funny enough this is not really a bad thing viewed from the perspective of promoting a greater total amount of savings, but it does show that sponsors could improve outcomes by using more aggressive plan designs. 

“Tied to this figure, another item that sticks out in the data is the number of employers that use just a simple methodology for their match,” Barlow says. “It is only a small segment of employers that are right now doing a tiered match or a stretch match. I think those who are not thinking about this plan design feature are missing out on a big opportunity.”

By a “tiered match,” Barlow is referring to the concept of taking the employer contribution to the DC plan and segmenting it so as to promote greater levels of savings. So in other words, the employer could match 50 cents per dollar on the first 3% saved and then offer a full dollar-for-dollar match on savings greater than 3% of salary, up to whatever limit they choose. The data set shows the deferral rate issue is being addressed by plan sponsors, with some effect: default deferral percentages associated with automatic enrollment programs continue to increase year-over-year in BMO surveys. As of the latest survey, the number of plans with a default deferral of over 5% has increased for the sixth straight year.

“Employees really want guidance from the employer on this stuff,” Barlow adds. “There are some concerns about being overly paternalistic that employers commonly bring up, but we know that for the most part, employers have a great experience when they make these changes and try to be more activist with the retirement plan.”

Other findings show some employer types have not seen the drop-off in average deferral rates—denoting the way trends in plan design have played out differently across different sectors.  Transportation, utilities and communications employers, for example, have seen their average deferral rate hold steady over recent years at about 6.9%. On the other side of the spectrum, the media, entertainment and leisure sector has seen its average deferral rate nearly halved since 2012, falling from over 8% to 4.2%. The average deferral rate increased in some employment sectors, including manufacturing, growing from 5.8% in 2012 to 6.6%.

Barlow encouraged plan sponsors and advisers to dig into the survey data on their own to identify the trends that are most important for their particular niche, as there is far too much to cover in one article or interview. Among the other findings he discussed was the pretty sizable drop-off seen in use of target-date funds (TDFs) as the qualified default investment alternative (QDIA). According to the latest data available, 79% of plan sponsors reported using TDFs as the QDIA in 2015, but this has dropped to 64%. Also notable, the use of target-risk funds as the QDIA has steadily decreased since 2010, falling from a high of 22% to 9%.

“Interestingly, there seems to be a pretty small but dedicated group of plan sponsors that really likes the target-risk approach,” Barlow notes. “I actually think there is a large population of plan sponsors and participants that is missing out, which could benefit from having access to target-risk funds, not necessarily as the QDIA, but as an option for those ‘do-it-with-me’ investors who are engaged enough to really define their risk tolerance and be somewhat more sophisticated than the general QDIA user.”

Turning to plan cost data, there is clear evidence of a broad downward trend in plan fees. In fact, plan fees have fallen for all sizes of plan sponsors except those with between $10 million and $50 million in assets. Plans in this category have actually seen their plan fees slightly increase on both an asset- and participant-weighted basis. Barlow suggests this is quite an important figure to consider, especially for advisers and consultants, as there is also evidence that the under-$50 million plan segment stands in need of much greater advisory professional support.