A new study finds that automatic enrollment not only triples the participation rate of new hires, but that over time the vast majority increase their deferral rates.
The report—“Automatic enrollment: The power of the default” by researchers at Vanguard, found that among new hires, participation rates triple to 91% under automatic enrollment, compared with 28% under voluntary enrollment. Over time, 9 in 10 participants increase their deferral rates, either automatically or on their own, and more than three-quarters of participants remain exclusively invested in the default investment fund.
The study is based on 813,918 newly hired eligible employees in 520 plans, specifically those hired between Jan. 1, 2017, and Dec. 31, 2019, and who were still employed by the plan sponsor as of June 30, 2020.
The reasons for focusing on new hires may be obvious, but the Vanguard researchers commented that they did so because it was “the most common way that the feature is first introduced into DC plans.” Of course, that means that those in this sample are younger, have shorter tenure (an average of about one year) than the general participant population, and have median account balances of (just) $6,500. A cautionary note on this group, however—high turnover rates are common in this group. In fact, over the sample period, 4 in 10 eligible employees left the sample because of job change. Indeed, after three years, 92% of participants hired under automatic enrollment were still participating versus 29% of participants under voluntary enrollment.
Automatic enrollment raises plan participation rates most dramatically among young and low-income workers. Consider that even those earning less than $15,000 had a participation rate of 82% under automatic enrollment versus 4% under voluntary enrollment. Similarly, 9 of every 10 employees younger than 25 were plan participants under automatic enrollment, compared with fewer than 2 in 10 under voluntary enrollment.
In recent years, we’ve seen a tendency on the part of plan fiduciaries to increase the default deferral rate from the traditional 3% starting point—long considered a rate low enough to discourage opt-outs, if not truly enough to provide retirement income adequacy. However, the Vanguard research suggests that employee quit rates do not appear to vary in response to a plan sponsor’s choice of the initial deferral rate. The participation rate among employees earning $15,000–$29,999 is around 85%—regardless of whether the initial deferral rate is 2% or 6%.
There’s been anecdotal evidence of a certain “stickiness” in initial default rates under either automatic or voluntary enrollment—and, in fact, the Vanguard research noted that while with the latter, after three years the average participation rate climbed to 29% from 21% initially—they held at 92% with automatic enrollment—after the first six months and after three years.
So, what happens with that default rate over time? Well, if there is no automatic increase feature, the fraction of participants who remain at the default deferral rate set by the employer declines over time—from 50% after 12 months to 37% after three years. That said, a third of participants chose to override the employer’s default and raise deferral rates after three years, while another quarter have chosen to override the employer’s default, raise their deferral rate, and sign up for a deferral rate increase. Indeed, more than 9 in 10 eligible participants after three years remain at the default deferral rate—or higher.
As for plans with automatic increases, after three years, about half of participants remain in the original automatic plan design, including the automatic increase, 17% have increased their contribution rate (while retaining the increase feature), and another quarter have boosted contributions—but dropped the auto-increase. Still, 9 in 10 participants wound up with deferral rates above the initial default design.
As for whether automatic enrollment winds up dampening contribution rates (a “ding” against automatic enrollment has been that folks start and stick with that low default rate, whereas if they had signed up on their own, they’d contribute more, at least to the level of the match), the Vanguard researchers saw something different in their results. Acknowledging that that result might be true in the aggregate for individual participants, and that even in their sample the average participant contribution rate for new hires in voluntary plans is slightly higher (7.0%, versus 6.4%), that gap narrows as plan sponsors adopt higher starting defaults. Moreover, when they exclude eligible but non-participating workers from the calculations, they found that voluntary enrollment “yields much lower contribution rates than automatic enrollment—1.9% versus 5.8% over the three-year period.”
The study found that participants in automatic enrollment plans are about 30% more likely to remain in the default investment option designated by the employer (86% of AE participants stay 100% invested in the default, compared with 66% of VE plan participants). In fact, the report notes that after three years, about 8 in 10 participants are still directing 100% of their contributions to the default investment option, and another 17% are using the default investment in combination with other plan investment options.
The difference wouldn’t appear to be much, but the researchers acknowledge what they call a “longstanding question”—specifically a concern that automatically enrolled participants might have higher debt levels since they are saving at higher levels. While within the time period in question AE participants were found to be slightly more likely to have a loan outstanding (24% versus 20% of those who voluntarily enrolled in the plan), overall, roughly three-quarters of participants do not borrow from their accounts during this period, regardless of plan design.
Moreover, the paper concludes that, while there are more participants with loans, there are still more eligible employees participating without a loan under automatic enrollment than in plans with voluntary enrollment designs.
Ultimately, the research found most notable the fact that among all eligible employees, automatic enrollment plus an automatic increase feature generally lead to higher employee contributions over time.
 The report comments that this sample includes both plans with an automatic annual increase and those without such a feature. Noting that participants in plans with an annual increase feature have lower account balances than those in automatic enrollment plans with no increase feature, it also reports that they have higher account balances than those in voluntary enrollment plans. (Also noted was that participants in the latter category have lower wages than those in automatic enrollment plans.)
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