Smarter Start Boosts Savings Rates

New research suggests that a few relatively minor changes in plan design – heavily influenced by advisors – can have a significant impact on employee savings levels.

The analysis by David Blanchett, Morningstar’s Head of Retirement Research, uses a combination of plan data and online participant surveys to evaluate the relative impact of what he terms “carrots, sticks, and nudges.”

The results strongly suggest that increasing default savings rates – what Blanchett calls the “nudge” – is likely the simplest and most effective way to get participants to save more for retirement. Default savings rate acceptance was roughly the same whether it was 3% or 12%, though participants who chose their own savings level tended to save more at higher default levels.

According to the survey respondents, the most common reason why they selected their current default rate is because it was recommended by an industry consultant or other professional.

Not surprisingly, participation rates were found to be significantly higher in plans with automatic enrollment, and when automatic escalation is available, savings rates improve for participants over time. Blanchett notes that roughly half of investors tend to accept the initial default savings rate regardless of level – up to 6% using empirical data (which shows what people actually do) and up to 12% based on the online survey (which marks what people say they would do, but might not hold up in reality). He notes that participants who reject the default rate tend to select higher savings rates, on average, as default rates rise. This suggests that default savings rates play “an incredibly valuable role both as a psychological anchor in setting expectations for participants’ savings decisions as well as driving average initial savings levels,” and therefore Blanchett says that plan sponsors should be “aggressive when selecting the initial default savings rate, aiming significantly higher than 3% default savings rate selected today.”

Match Sticks?

While the employer match is often cited as one of the top reasons employees choose to participate in a DC plan, Blanchett notes that the match amount – this is his “carrot” – doesn’t conclusively improve participation (after controlling for auto enrollment), although he says the evidence “strongly suggests” that match levels affect deferral rates. He extrapolates from this to encourage plan sponsors to consider “stretching” the match to get participants to save more for retirement.

Not surprisingly, 90% of participants who engaged with an in-plan advice solution – Blanchett’s “stick” – increased their savings rates, by about 2 percentage points on average. That said, Blanchett acknowledges that individuals who seek out advice may already be motivated to save more.

While automatic escalation can increase savings rates once employees start participating in the plan, this feature is “relative rare” according to the paper (citing a Northern Trust survey that indicates 32% of plans offer it), and many plans that offer the feature make participants opt into it.

The results of the online survey suggested that the default and employer contribution levels resulted in higher average aggregate savings rates. However, Blanchett notes that these approaches should not be viewed as mutually exclusive. Rather, as in his analysis of default savings rates, he notes that when participants received a higher savings recommendation, they tended to save more on average. That, he says, suggests that advice solution providers should also be aggressive when providing savings guidance to participants.

In sum, Blanchett says the findings suggest that plan sponsors interested in improving initial employee savings levels should adopt automatic enrollment and select an aggressive default savings level (at least 6%, potentially 8% or 10%) that is ideally coupled with some type of employer matching contribution. He notes that automatic escalation and some type of in-plan advice solution can further improve savings rates, and that plan sponsors concerned about the potential additional costs associated with higher levels of participation (and higher savings rates) could consider “stretching” the match to a higher level and/or changing the match rate to a discretionary formula.

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