Proponents of automatic features for DC plans have long argued that they boost participation and savings rates, and a recent study confirms that belief.
“Automatic enrollment in employer‑sponsored 401(k) savings plans has transformed the way that millions of Americans save for retirement,” say Joshua Dietch, Head of T. Rowe Price Retirement Thought Leadership, and Taha Choukhmane, Ph.D., MIT Sloan School of Management Associate Professor of Finance in their report, Automatic enrollment’s Long‑Term Effect on Retirement Saving.
Setting the Table
More 401(k) plans are offering automatic enrollment along with higher employee default deferral rates, observe Dietch and Choukhmane—and this has been in the works for longer than many people think. They note that while many believe that the 2006 Pension Protection Act (PPA) was the catalyst for auto features, the IRS actually paved the way in 1998 in Revenue Ruling 98-30. That ruling enabled employers to use “negative consent” to automatically enroll employees in the 401(k) they offer, requiring employees opt out of they chose not to participate.
After PPA Enactment
It may not have been the initial catalyst, but the PPA did have a significant effect, write Dietch and Choukhmane. They report that the number of plan sponsors that are T. Rowe Price clients and set automatic enrollment in place doubled in the 15 years after the PPA was enacted, from 37% in 2006 to 74% in 2021. They attribute that to a variety of factors, including:
- federal preemption of state laws which may have prohibited automatic enrollment;
- fiduciary protection for qualified default investment alternatives (QDIAs); and
- a new safe harbor for qualified automatic contribution arrangements (QACAs).
And the prevalence of automatic enrollment is not all that has increased, say Dietch and Choukhmane. They note that the most common default rate had been 3%, which they suggest was the result of IRS rulings that used 3% as an example default rate. But by 2018, 12 years after the PPA was enacted, the percentage of T. Rowe Price clients that used 3% as the rate fell from 61% to 31%; further, the percentage of their clients setting the rate at 6% jumped from 4% to 36%.
By December 2018, according to T. Rowe Price Retirement Plan Services, participation in plans with automatic enrollment stood at 85% with an average deferral rate of 7.8%; among plans that had not implemented auto enrollment and required employees to opt in, however, participation was less than half that of plans with auto enrollment—39%.
Effect of Automatic Enrollment
In research concerning the effect of automatic enrollment, Choukhmane’s findings included the following.
- Enrollment is a learned behavior. Choukhmane says that the research suggests that employees who have been automatically enrolled in the past are less likely to join a new plan with an employer does not offer automatic enrollment. He adds that the research also suggests that there is a risk that employees who are automatically enrolled could become conditioned to it, and that if it is not offered by a future employer, they could delay savings opportunities or miss them altogether.
- Higher default rates don’t dramatically hurt saving. Research suggests that raising the default rate will not result in a high opt-out rate, Choukhmane says. He cites T. Rowe Price data showing that a 1 percentage point increase in the default rate caused a 1 percentage point drop in participation.
- Auto enrollment can be a “nudge” toward saving. The report cites earlier research by Cass Sunstein and Richard Thaler which indicated that automatic enrollment nudges employees toward saving, but Choukhmane still argues that automatic enrollment should be “well-considered and purposeful.”
- Especially pronounced effect on particular employees. Choukhmane found that employees who earned low wages may not have saved if their employers had not instituted auto enrollment. Further, younger employees could benefit from automatic enrollment by making it possible for them to compound returns over longer periods.
- Opting out is not a disaster for higher-income employees. Choukhmane notes that not participating does not necessarily mean that employees who have incomes above the median won’t be saving. He found that such employees can “catch up” and that within three years, those who voluntarily opt in save at levels comparable to those of employees who were participating in the plan due to auto enrollment.
Choukhmane suggests that plan sponsors endeavor to maximize how effective their retirement plan designs are, and that they strike “an optimal balance” by carefully considering:
- what outcome they desire;
- their budget;
- what they know about employee behavior; and
- what they intend to accomplish through a plan design.
Behavioral economics, Choukhmane says, “ultimately demonstrates” is that there is not just one way to increase participation in a plan and employee savings. He argues that combining automatic elements—enrollment, escalation and reenrollment—can “lead to optimal results.” And Choukhmane also argues that plan design should reflect the fact that an employer’s workforce may include people at different stages in their professional lives.