IMHO: “Starting” Points

It started on July 7 when TheWall Street Journal ran a front-page story titled “401(k) Law Suppresses Saving for Retirement” (a story that is still, as I write on Saturday morning, on WSJ.com’s most popular listing).  And, no, that article wasn’t talking about discrimination testing rules, the imposition of annual contribution limits, talk of a mandatory limit on loans, or the imposition of mandatory annuitization of distributions.  Rather, it was talking about…automatic enrollment.

The report claimed that “40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily,” citing data from the Employee Benefit Research Institute (EBRI).  The problem, according to the report, was that “[m]ore than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise.”

 Well, duh.  That, as they say, is the law.

EBRI quickly took issue with the WSJ’s characterizations, outlining in some detail the non-partisan group’s extensive history in examining these trends, and then noted that “The Wall Street Journal article reported only the most pessimistic set of assumptions,” failing to “cite any of the other 15 combinations of assumptions reported in the study” referenced in the report.  More significantly, EBRI’s Jack VanDerhei commented later that same day that the WSJ managed to completely ignore the reality that automatic enrollment is “increasing savings for many more—especially the lowest-income 401(k) participants.”

Now, while EBRI was, IMHO, rightly miffed to see its data and analysis mis-, or perhaps less-than-fully, represented, the authors of the Pension Protection Act were no less maligned.  The law was designed to help more employers make it easier for more employees to become participants, and for those participants to become more-effective retirement savers, and it seems to me that, in just about every way, it has been a huge success.  Are there those who once might have filled out an enrollment form and opted for a higher rate of deferral (say to the full level of match) that now take the “easy” way and allow themselves to be automatically enrolled at the lower rate called for by the PPA?  Absolutely.  However, as the EBRI data show—and, for anyone paying attention, have shown for years now—the folks most likely to be disadvantaged by that choice are higher-income workers, most of whom, IMHO, should know better.   

The simple math of automatic enrollment is that you get more people participating, albeit at lower rates (until design features like contribution acceleration kick in).  Said another way, participation rates go up, and AVERAGE deferral rates dip—initially.¹  Then, over time, as contribution-acceleration designs take hold, we’re likely to see those average deferral rates increase².  But for some, it will mean less savings, and for many, perhaps not savings enough. 

There are, however, some things plan sponsors can do now to keep things moving in the right direction sooner:

Auto-enroll workers at higher rates, perhaps as high as the level at which they will receive the full company match.  Sure, the Pension Protection Act calls for 3% as a minimum to be eligible for its safe harbor—but there’s no law/rule that says you can’t go higher.

Auto-enroll ALL workers, not just new hires.  Since the PPA’s introduction, PLANSPONSOR’s DC Survey has consistently shown that two-thirds of employers adopting automatic enrollment do so on a PROSPECTIVE basis (see IMHO: A Prospective Perspective).  Do you really care more for the people you just hired than those who have devoted years of loyal service?

Remind ALL participants of the importance of actively saving for retirement.  It may be a bit counter-intuitive to try to reach automatically enrolled participants who didn’t even take the time/expend the energy to fill out an enrollment form, but it’s important.  By most measures, workers who save only to the level of the company match won’t have saved enough to provide a financially secure retirement.  However, a generation of participant behaviors suggests that they assume that saving to the level of the match is the “right” answer, and it’s likely that they will assume that the level of automatic enrollment established is “enough.”  We all know better.

IMHO, automatic enrollment designs are, literally, a starting point—for plan sponsors and their soon-to-be participant savers alike ⁽³⁾.  

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The WSJ article is online at http://online.wsj.com/article/SB10001424052702303365804576430153643522780.html?mod=WSJ_hp_LEFTTopStories.  EBRI’s response is at https://ebriorg.wordpress.com/  

¹ Complicating the picture is that the PPA took hold just ahead of an economic downturn that led a small, but noticeable, group of employers to reduce and/or suspend their match (and a not-so-small group to lay off lots of workers), while health-care costs continued to rise and, based on previous surveys, likely siphoned some participant contributions from retirement savings. 

² VanDerhei notes on EBRI’s blog that “[t]he other statistic attributed to EBRI dealt with the percentage of AE-eligible workers who would be expected to have larger tenure-specific worker contribution rates had they been VE-eligible instead. The simulation results we provided showed that approximately 60 percent of the AE-eligible workers would immediately be better off in an AE plan than in a VE plan, and that over time (as automatic escalation provisions took effect for some of the workers), that number would increase to 85 percent.”

⁽³⁾ This from a column I wrote about automatic enrollment designs in 2005: “More troubling still – there is at least one published study that indicates that, over time, the establishment of a default deferral rate seems to lower the overall rate of deferrals in the plan.  Mostly, this seems to be a result of an increase in the number of workers who simply leave their choices in the hands of the default option.  But it is hardly beyond the realm of reason to imagine a scenario where workers take the establishment of a default rate as being the “right” answer for them as well.

All in all, advisors should remember that the results of automatic deferrals, however encouraging at the outset, should not be left unattended.  An “automatic” deferral is a start, perhaps even a good start.  It should not, however, be the end of the matter.