Automatic 401(k) deferral rates could be higher

Since most participants accept the deferral rates that are automatically set in 401(k) plans, sponsors should increase those rates to at least 6% or higher, The Principal says.

In fact, participants should be saving at least 11% to 15% of their pay, including employer match, throughout their entire careers, said Barrie Christman, vice president of individual investor services at The Principal.

“Automatic enrollment is a powerful tool to encourage better retirement savings behavior, but we’ve found that most plan sponsors tend to set their default at what we believe is an insufficient level,” Christman said. “By boosting the default rate, plan sponsors can help their participants improve savings rates without sacrificing participation.”

When contribution rates are automatically set at 3%, almost half (45%) of participants leave their contributions at that level, The Principal found. But another 36% raise their contributions to an average of 6.7%. Another 3% decrease their deferral rates to an average of 1.5%, and 15% opt out entirely.

When contribution rates are automatically set at 6%, a higher proportion of employees (49%) leave their contributions at that level, but another 18% raise their contributions to an average of 11.8%. However, 14% decrease their deferral rates to an average of 2.9%, and 19% opt out altogether.

The Principal noted that automatic enrollment at 6% increased opt-outs by just four percentage points. The Principal added that automatic enrollment boosts participation in 401(k) plans by 20%.

Data also shows that when employers include a match in their 401(k) plan, savings rates and participation is even higher.

In plans with a 3% default rate that include an employer match, 45% of employees are saving a total of between 6% and 10.99%, and 32% are saving 11% or more. In plans with a 6% default rate that include an employer match, 31% are saving between 6% and 10.99%, but a considerable proportion (61%) are saving 11% or more of their salaries, The Principal found.

“In order to generate sufficient retirement income, we believe most retirement plan participants should be saving 11% to 15% of their pay—including employer match—throughout an entire working career,” Christman said. “It’s clear that participants who are automatically enrolled at a higher level are more likely to hit that all-important savings range.”

Christman added that auto-escalation of deferral rates over time is another way to help participants prepare adequately for retirement.

Lee Barney writes for Money Management Executive, a SourceMedia publication.