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Is Auto-Enrollment Helping or Hurting Long-Term Retirement Saving?

Industry Trends and Research

There is little doubt that the use of auto-enrollment has helped increase participation rates. But could it also lead to lower savings rates?  

Auto-Enrollment's Long-Term Effect on Retirement Saving, a new white paper from T. Rowe Price, explores that possibility, examining whether automatic enrollment in a 401(k) plan increases lifetime wealth accumulation and benefits all participants equally. 

Authors Joshua Dietch, T. Rowe’s VP for Retirement Thought Leadership, and Taha Choukhmane, Ph.D., a retirement researcher at the National Bureau of Economic Research and MIT Sloan School of Management, found that auto-enrollment nearly doubles plan participation and successfully gets participants who might not have otherwise saved saving. They also find, however, that it can result in participants saving less than those who voluntarily opt in and set their own deferral rate.

The paper is based on research conducted by Choukhmane analyzing data from 600 firms recordkept by T. Rowe covering 4 million employees over the years 2006–2017, as well as a secondary set of data from the UK’s “NEST” defined contribution plan. 

Learned Behavior

The paper explains that when NEST was being implemented, some employers were required to automatically enroll their employees, while others were not. In tracking individuals’ enrollment behaviors as they changed jobs, Choukhmane determined that auto-enrollment and opt-in enrollment are learned behaviors.

According to the research, employees who have experienced auto-enrollment in the past are less likely to join a new plan where the employer does not offer auto-enrollment, while employees who were required to opt-in enrollment were more likely to participate and contribute a higher percentage of pay.

The research also suggests that the employees who are auto-enrolled “run the risk of becoming conditioned to it, and its absence at future employment can result in missed or delayed savings,” the paper states. 

Package Deal

For employees to fully benefit from auto-enrollment, Dietch and Choukhmane contend that it needs to be combined with auto-escalation. “That way, employees can enjoy the benefits of compounding rates of return by saving early in their careers and may be able to avoid the need to save more later in order to compensate for missed opportunity,” they write. 

The paper further suggests that participants will not opt out if the auto-enrollment default rate is raised.  T. Rowe’s analysis looked at the effect of employers raising their defaults above 3% and found that there is minimal impact, with a near consistent 1% drop in the participate rate for every 1% increase in the default rate.  

“While some may be concerned about a slight decrease in participation, the broader context shows that a clear majority of participants benefit from greater savings compared with the relative few that opt out,” the authors observe. Moreover, they note that it’s plausible that many of those who opt out may still participate in the plan, but at a lower default rate.

Who Benefits?

When looking at who ultimately benefits from auto-enrollment, Choukhmane segmented the research by the amount of employee savings in relationship to their wages. Not surprisingly, he found that if not for auto-enrollment, low-wage earners might not otherwise save, and younger employees could potentially enjoy greater benefit from compounding returns over longer periods of time. 

Both younger and lower-paid workers were found to benefit from defaults in general and investing in a target date portfolio in particular. According to the research, this cohort of workers who invested in a target date portfolio could accumulate as much as 41% more in lifetime wealth compared with those who had to proactively opt in to participate in their employer’s plan. 

Dietch and Choukhmane further observe, however, that the benefit of auto-enrollment is less significant for higher-wage earners. Further, they emphasize that “behavioral finance research has shown that high-wage earners may undersave as a negative, yet unintended, consequence of the framing or endorsement resulting from the default rate.”

Overall, they conclude that plan sponsors must consider their “purpose and intention” for offering a plan when evaluating plan design features. “What this research ultimately demonstrates is that there is no single solution to increase both participation and savings,” they write. “Rather, it is the combination of design approaches, such as auto-enrollment, auto-escalation, reenrollment, etc., that can lead to optimal results.”