Adding automatic enrollment to a 401(k) retirement savings plan builds retirement savings. It especially helps lower and moderate income workers, but employees at all income levels start to save earlier, save more, and have better investment choices than similar plans without that mechanism. This simple fact is true despite some press reports and blog entries suggesting that automatic enrollment may “hurt” retirement savings.
Automatic Enrollment Helps Workers to Save
First a quick explanation: Automatic enrollment reverses the traditional way that people sign up for a 401(k) retirement savings plan by placing them in the plan, saving a set percentage of their income and investing in a specific automatic investment choice unless the worker decides otherwise. The worker continues to have full control and can at any time decide to stop saving, to save more or less, or to change investment choices. However, if the worker does nothing, he or she has started to save for retirement, often much earlier than he or she would have otherwise. Studies show that automatic enrollment especially helps the four groups most likely to under save for retirement: women, younger workers, minorities, and lower paid workers. Under automatic enrollment, participation rates for those groups went from under twenty percent to over eighty percent.
The best results for a worker’s experience in a 401(k) retirement savings plan comes from a combination of automatic enrollment of both new workers and non-participating existing employees, combined with an adequate employer match and an automatic escalation feature that gradually increases over time the percent of income that an employee saves. These features are common among plans offered by larger employers, and their use is growing in smaller ones as well.
An April report from Jack Vanderhei of the Employee Benefit Research Institute (EBRI) estimates that without automatic enrollment, the lowest 25 percent of workers measured by annual income would retire with a mere 0.08 percent of their last year’s pay. This is not even enough for a good party, much less a secure retirement. However, the report shows that if all 401(k) plans were to use the same automatic enrollment features as larger plans do, the same lowest 25 percent of workers would retire with savings of between 5 times and 5.33 times their earnings just before retirement. Combined with their Social Security benefits, this level of savings is certainly enough for a comfortable retirement.
The top 25 percent of workers measured by income shows a similar increase in the amount of retirement savings after automatic enrollment than they would have without the mechanism. Their level of savings rises from an estimated 2.41 times their final annual earnings to between 9.15 times and 9.81 times final earnings. In addition, a Retirement Made Simpler study shows that workers who have been automatically enrolled strongly support the mechanism and start saving before they would have otherwise.
The “Controversy” About Automatic Enrollment
The “controversy” comes from a Howard Gleckman blog posting on the Urban-Brookings Tax Policy Center entitled “Why Auto-enroll 401(k)s May Reduce Retirement Savings” , which describes a December 2009 paper by noted researchers Mauricio Soto and Barbara Butrica. Gleckman’s posting was picked up by Ezra Klein’s Wonkbook column on Washingtonpost.com using the same title that Gleckman used .
Gleckman’s mistake is clear when one looks at the title of the original December paper: “Will Automatic Enrollment Reduce Employer Contributions to 401(k) Plans?” In short, the Soto-Butrica paper only looks at whether employers reduce their match of employee savings after a plan adopts automatic enrollment. Lacking actual data on employer matches, Soto and Butrica’s simulation estimated that information. Their conclusion is that the overall amount paid out by employers as a match for employee savings in a 401(k) plan is only 93 percent of what it was before automatic enrollment was adopted.
A slight reduction in the employer match (more on that in a moment) is vastly different from an overall reduction in retirement savings. Soto and Butrica recognize that “auto enrollment increases the number of workers participating in private pensions.” Even if those new savers did receive a slightly smaller match, their savings plus the employer match at whatever level it is will result in more retirement savings, and not less. This is especially true for the new savers who would not have been participating otherwise. Again, these workers are much more likely to be younger and have lower incomes than those enrolled under a traditional enrollment system. Automatic enrollment especially helps those who most need retirement savings.
Even Soto and Burtica’s limited findings are controversial. An the April report from Jack Vanderhei of the Employee Benefit Research Institute (EBRI) of 225 large corporate retirement savings plans using actual data from those plans came to the alternate conclusion that under automatic enrollment, employers were more generous after starting automatic enrollment than they had been before the mechanism was adopted. In fairness, the Vanderhei study included plans from employers who had switched from a traditional pension plan to a retirement savings plan, and had increased their match as a result, but even so, it raises serious questions about Soto and Butrica’s results.
Vanderhei’s study joins a host of other findings all showing that automatic enrollment means the difference between tiny levels of retirement savings and retirement security. Automatic enrollment increases retirement savings for all workers, but especially helps those who most need to save.