How 401(k) automatic features can boost retirement savings
The U.S. tax reform bill that passed late last year has companies seeing lower tax rates and more cash on their balance sheets. The windfall provides companies with an opportunity to use newly available funds to directly benefit their employees. As organizations embark on 2019 planning, now’s the time to reevaluate retirement plan design and establish new ways — such as automatic services — to encourage plan participants to save for retirement.
Offering automatic features in retirement plans are a way that companies can maximize employee participation and encourage participants to contribute at higher rates. Retirement advisers and plan sponsors are modernizing traditional auto-services to begin thinking about how they can be customized based on the financial health of varying employee populations.
Auto-enrollment default rate: Auto-enrollment features can have a direct impact on both participation and contribution rates. Our annual Reference Point report shows participation rates are 42 percentage points higher in plans that offer auto-enrollment in 2017 than those that do not. However, participation is just one element of the complex task of building retirement savings; how much people are saving is also important to retirement success. Plan sponsors should set the default deferral rate to at least 6% of an employee’s salary.
Historically, employers have defaulted participants at a 3% savings rate. This is not sufficient. Behavioral finance research shows that setting a low default rate influences participants to view the default deferral as the recommended and ideal savings rate. As a result, participants do not increase their savings rate beyond this. However, employees are open to saving more — and tend to do so when employers enroll them at higher rates. T. Rowe Price’s 2015 Retirement Spending and Saving study showed that 73% of workers with a 401(k) were satisfied that their employer auto-enrolled them. Approximately 43% wished their employer had enrolled them at a higher contribution rate.
Auto-escalation: The most effective way to implement automatic increases to the deferral rate is to make them the default option. Two-thirds of participants will stick with the choice their employers make while 13% will choose to opt in to the automatic increase option on their own. An investor who starts contributing 6% toward retirement and increases the deferral rate by 2% each year will almost have as much saved after 35 years as someone who saved 15% from the outset. Meanwhile, a worker who never increases the deferral rate has at least 50% less savings when they are near retirement age.
Employer match: An employer match is another method that can significantly influence savings rates. Our research found that 50% of all workers — including 54% of millennials — are very likely or absolutely certain to increase their contribution rate, in order to get the maximum match.
Stretch match: A stretch match encourages plan participants to save more in order to receive the maximum benefit of the plan sponsor’s contribution matching formula. T. Rowe Price’s 2016 Human Resources Perspective: A Survey of Larger 401(k) Plans found that while half of plan sponsors are still using a traditional matching formula (50%), 38% have adopted a stretch match formula.
A successful retirement requires a partnership between plan sponsors and their participants. Offering auto-features in plans and educating participants on these benefits can influence participation, encourage better financial behavior, and aid individuals on the path to a financially secure retirement.