The unintended consequence of 401(k) auto-enrollment
Commentary: Auto-enrollment, codified in law by the Pension Protection Act of 2006, was drafted with the best of intentions — to increase Americans’ retirement savings — but it has had the unintended consequence of impairing plan effectiveness. By proliferating small accounts in plans, auto-enrollment has caused a decrease in average account balances throughout the U.S. retirement system. Adding to the urgency of this issue is the rising rate of auto-enrollment adoption across defined contribution plans of all sizes, but particularly among larger plans.
According to Form 5500 data, DC plans with auto-enrollment, across all industries, have average account balances which are 7% lower than those without auto-enrollment. When we look at individual industries, the impact of auto-enrollment on average account balances is much more pronounced.
For example, the difference between average account balances of plans sponsored by educational service companies with and without auto-enrollment is staggering — the overall average account balance for the latter is 164% higher! This trend manifests itself in varying degrees among sponsored plans in many other industries, including furniture and related product manufacturing (123%); beverage and tobacco product manufacturing (108%); securities, commercial contracts and other financial products (33%); real estate (21%) and telecommunications (21%).
Research shows that a plan’s recordkeeping and administrative fees tend to be inversely proportional to its average account balance (see previous blog post). If your plan’s average account balance is declining, you may be paying more in fees than you would if it was stable or increasing.
Also see: “Reduce plan fees by increasing account balances.”
The core objective of portability is systematic account consolidation, which counterbalances the harmful side effects of auto-enrollment by increasing a plan’s active participant account balances. Portability solutions reduce the many frictions associated with moving an account from one plan to the next, and have been proven to reduce leakage and the cost of maintaining multiple retirement savings accounts.
Implementing portability solutions for participants helps sponsors mitigate the negative impact of auto-enrollment by actively encouraging new hires to consolidate their savings into their current plan — and simultaneously helping separated participants to roll their balances into their next employer’s plan. Adopting auto-portability for the smallest accounts fully bridges the gap between mandatory distributions (for balances under $5,000) and auto-enrollment, encouraging the preservation of savings among millennials (a population segment at extreme risk of cashing out).
The vast majority of plans are capable of accepting roll-ins of accounts from other plans and IRAs. The Plan Sponsor Council of America’s annual study released in November 2013 reported that 98.4% of 401(k) plans accept plan-to-plan roll-ins, and 65.5% accept roll-ins from IRAs. Sponsors can enhance the value of their plans (and increase their average account balances) by engaging specialized portability solution providers to assist participants with the roll-out and roll-in processes. Both transactions have the beneficial effect of preserving savings within the qualified plan system, and characterize two sides of the same roll-in coin; one plan’s roll-out is another plan’s roll-in, and vice versa.
Portability solution providers can also track down lost/missing participants for sponsors — as well as help sponsors counsel participants against cashing out when they change jobs, and assist participants with moving balances to their new plans.
Auto-enrollment is a useful tool for helping Americans save more money for retirement, but on its own, it can adversely affect plan sponsors and the U.S. retirement system as a whole. However, when auto-enrollment is combined with solutions that enable easy portability of retirement accounts, both sponsors and participants can benefit.
Spencer Williams is president and CEO of Retirement Clearinghouse, a portability solutions provider.