In a testament to the willingness of plan sponsors to implement smart plan design, retirement plan participants broke new savings records in 2021, yet there is still more to be done, according to Vanguard’s newest edition of How America Saves.
The firm notes that it saw record-high participation and deferral rates as well as a higher percentage of participants in target-date funds (TDFs) and advised solutions such as managed accounts than ever before. Still, while employers have made significant progress in adopting plan design features, the firm observes that many participants are facing increasingly complex financial situations that can compromise their retirement savings efforts.
In fact, the firm’s 110-page analysis of nearly five million 401(k) accounts recordkept by Vanguard—along with the companion piece Insights to Action—illustrate several areas for improvement that plan sponsors can address to further drive participant outcomes and optimize their plan design.
“There is no doubt that plan sponsors’ efforts over the last two decades have helped improve the retirement readiness of millions of Americans,” says John James, Managing Director and Head of Vanguard Institutional Investor Group. “However, workers’ needs are evolving and so too should plan design. Plan sponsors are uniquely positioned to support their employees’ financial well-being with integrated tools, advice and services that can help improve their overall financial peace of mind.”
Automatic Savings Features
Thanks to automatic deferrals and increases, savings rates have remained steady. In fact, at year-end 2021, 56% of Vanguard plans had adopted automatic enrollment, including 75% of plans with at least 1,000 participants. And because larger plans were more likely to offer it, 70% of participants were in plans with an automatic enrollment option.
Additionally, two-thirds of automatic enrollment plans have implemented automatic annual deferral rate increases. Automatic enrollment defaults have also increased over the past decade. Fifty-eight percent of plans now default employees at a deferral rate of 4% or higher, compared with 32% of plans in 2012, the report notes. And nearly all plans (99%) with automatic enrollment defaulted participants into a balanced investment strategy in 2021—with 98% choosing a TDF as the default.
Nonetheless, savings levels still may be insufficient for retirement readiness, the report suggests. The median total contribution rate—which includes both participant and employer contributions—stood at 10.4% in 2021, up modestly from 10% in 2017.
However, about half of all participants continue to save below the recommended savings rate of 12% to 15% or more of their salary to meet their retirement goals. “The good news is that about 20% of participants are within 1% to 3% of their target saving rate, so minor behavioral adjustments could benefit many of them,” James emphasizes.
To address this, the report suggests that plans consider defaulting participants at 6%, or at least to the employer match, and performing reenrollment, automatic escalation and undersaver sweeps. As to concerns about opt-outs, Vanguard’s research suggests that employee quit rates do not appear to vary in response to a plan sponsor’s choice of the initial deferral rate—whether, for example, it’s 3% or 6%.
Professionally Managed Portfolios
Vanguard further suggests that plan sponsors consider broadening the scope of retirement plans to support participants’ financial well-being with self-directed solutions and advice that goes “to and through retirement.” The report observes, for example, that TDFs and other professionally managed allocations have improved portfolio construction and have reduced frequent trading and extreme equity allocations among participants by three-quarters since 2006.
At year-end 2021, 64% of all Vanguard participants were solely invested in an automatic investment program—compared with 7% at the end of 2004 and 36% at year-end 2012. In addition, 56% of all participants were invested in a single TDF; another 1% held one other balanced fund; and 7% used a managed account program. Yet, more than half of participants over age 55 remain do-it-yourself investors, leaving some savers vulnerable to significant portfolio volatility.
“These diversified, professionally managed investment portfolios dramatically improve diversification compared with the portfolios of participants who make their own choices,” Vanguard emphasizes.
What’s more, the firm notes that over the past 15 years, it has observed a decline in participant trading, which is partially attributable to participants’ increased adoption of TDFs. Only 3% of participants holding a single TDF traded in 2021, according to the firm’s data. As such, the report suggests using a QDIA and choosing TDFs as the default option, as well as reenrolling participants into TDFs by sweeping them into an appropriate TDF, helping to ensure portfolios are age appropriate and properly diversified.
Cash Outs and Job Changes
Since participants are changing jobs more frequently and may risk retirement savings interruptions, Vanguard suggests that plan sponsors should strive to help ensure participants’ savings efforts continue unabated throughout their career.
The report notes that cashouts are disproportionately affecting younger, low-balance participants. Most participants with 401(k) balances of less than $1,000 voluntarily or are automatically cashed out of their retirement savings when they leave an employer, compared with just 7% of participants with balances over $100,000.
Participants who prematurely cash out their retirement savings risk immediate tax consequences and may forfeit future savings and returns if assets are not reinvested in a tax-sheltered account. Vanguard suggests that auto-portability services and revisions to minimum balance rules can help decrease cashout rates. In fact, one fix in the SECURE Act 2.0 would update the dollar limit for mandatory distributions
To help improve retirement readiness, the report encourages plan sponsors to consider adopting plan design features, such as higher default rates, immediate eligibility and vesting, and integrated financial well-being services. It notes, for example, that nearly a third of plan sponsors require employees to work at the company for a period before they are eligible to contribute to their retirement plan.
The data included in this report is drawn from several sources, including Vanguard’s DC universe, consisting of 1,700 qualified plans, 1,400 clients and nearly 5 million participant accounts for which Vanguard directly provides recordkeeping services. In addition, data on participation and deferral rates is drawn from a subset of Vanguard recordkeeping clients. Unless otherwise noted, all references to data are as of Dec. 31, 2021.
