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Plan Design Features Helping Small 401(k)s Improve Participant Outcomes

Practice Management

New research shows that small business plan participants are benefiting from enhanced plan design features, but some findings suggest that more can be done. 

Vanguard’s sixth annual “How America Saves: Small business edition,” reveals that employees enrolled in plans with an automatic enrollment feature have an overall participation rate of 82%, compared with a participation rate of only 54% for employees hired under plans with voluntary enrollment. 

The report, which looks at plan design trends and participant savings behavior in 401(k) plans with under $20 million in assets served by Vanguard, also finds that for individuals earning less than $30,000 in plans with automatic enrollment, the participation rate is more than double that of plans with voluntary enrollment. 

As a companion piece to the firm’s recently published “How America Saves” effort, Vanguard further notes that small business plan participants with enhanced plan design features are also benefitting from professionally managed allocations, which has led to optimized portfolio construction. In 2018, two-thirds of small business participants were invested in a professionally managed allocation, with a total of 61% of participants invested in a single target-date fund. Among new plan entrants, three-quarters of participants were invested in a single TDF. 

The percentage of participants holding broadly diversified portfolios was 79% in 2018, while the percentage of participants with no allocation to equities was 3%. Vanguard notes that at the other extreme, the fraction of participants investing exclusively in equities was 7%. “Positive participant behaviors coupled with the increased use of professionally managed accounts is making a difference in the retirement readiness of small business 401(k) plan participants,” notes Jean Young, senior research associate in the Vanguard Center for Investor Research and author of the report. “The increased use of the features and tools available points to the continued commitment by plan sponsors to further drive these improved outcomes.”

Contribution Levels

But despite the increased participation among auto-enrolled plans, a deeper dive into the report suggests that plans should consider doing more to enhance this feature. As of December 2018, 15% of Vanguard plans permitting employee-elective deferrals had adopted automatic enrollment. Half of these plans automatically enroll participants at a 3% contribution rate. More than a third of these plans automatically increase the contribution rate annually. 

On average, participants saved 7.1% of their income in their employers’ plans in 2018, with a median deferral rate of 5.1%. What’s noteworthy, however, is that plans with voluntary enrollment have average deferral rates that are 23% higher and median deferral rates that are 12% higher than plans with automatic enrollment. The report shows that participants joining a plan under an automatic enrollment feature have an average deferral rate of 6.1%, compared with 7.5% for participants joining plans under voluntary enrollment. 

As such, plan design – specifically the predominant use of a 3% default deferral rate – means participants enrolled in plans through automatic enrollment are saving less, Vanguard notes. “This is especially remarkable in light of the fact that participants earning less than $30,000 save twice as much, on average, under voluntary enrollment designs,” the report emphasizes. It further suggests that higher default deferral rates would be amenable to plan participants in automatic enrollment designs. “Our research on automatic enrollment indicates that ‘quit rates’ do not deteriorate when higher default percentages are used to enroll employees,” the firm says.

Additional data in the report shows that three-quarters of Vanguard small business plans provided either an employer match or nonelective contribution, or both, in 2018, the report notes. The average value of the total employer contribution was 4.8% in 2018, while the median value was 4%. However, the value of employer contributions varied significantly from plan to plan, ranging from less than 3% of wages for 17% of plans, to 10% of wages or more for 8% of plans.