Recent Trends in the 401(k) World-Is Auto the way to go?
By: Mark H. Woodward
March 4, 2016
Many 401(k) Plan sponsors have started to adapt a policy of auto-enrollment to increase participation in their plans. While some may argue the merits of such a policy, the benefits outweigh the risks in my opinion. Automatic enrollment in 401(k) plans forces participants to enroll and participate at (usually) a minimal contribution rate. Typically, auto-enrollment allows participants to opt out but research has shown that most participants do not opt out. One of the risks of automatic enrollment is that the plan sponsor must select an appropriate investment for the participants if they do not opt out and do not select an investment option from the plan's menu of available investments. In this instance, a plan should have investment options that qualify as Qualified Default Investment Alternatives (QDIA). The standard practice is to use target date funds (TDF) that are age appropriate for the investor based on the year they will reach their retirement age as defined by the plan.
Some suggest that while automatic enrollment is a good start, it is not enough and plan sponsors should consider utilizing other tools at their disposal to further encourage employees to save more and invest more appropriately. According to a J.P. Morgan survey of DC Plan Sponsors that resulted in a 2015 White Paper entitled "Aligning Goals, improving outcomes: 2015 Defined Contribution Plan Sponsor Survey Findings," sponsors can improve employee outcomes and more closely align their goals for the plan with employee retirement income goals by following three suggestions: 1) Offer auto-enrollment to boost participation, 2) Adopt automatic contribution escalation so participants save at higher rates, 3) Use target-date funds and reenrollment so employees invest more appropriately. Automatic contribution escalation involves increasing participant contribution rates until they reach a pre-determined maximum, typically 6%-10%. A reenrollment plan design strategy transfers participants' account balances automatically to the plan's qualified default investment alternative (QDIA), unless participants specifically opt out.
A new study by Vanguard, "DC Plan Reenrollment Improves Portfolio Construction, Reduces Cost," found that not only are portfolios better constructed but also participant fees can be reduced by as much as 75% under a reenrollment sweep. The study was conducted on a reenrollment for one large Defined Contribution (DC) plan client who moved a plan with 18,000 participants and over $1.2 billion in plan assets from another recordkeeping service provider onto the Vanguard platform. The fee savings was primarily driven by changing the plan's suite of target date funds (TDF) from more expensive actively managed funds to a suite of lower-cost passively managed TDFs. In addition to cost savings, the study looked at participants' opt out behavior and found that a vast majority of participants remained invested in the new TDF default. In fact, 6 months after the reenrollment event only 16% of participants had fully or partially opted out of the TDF default.
Based on these findings, plan sponsors should definitely consider "auto" programs for their 401(k) plans. Auto-enrollment, auto-escalation and reenrollment programs can be used to increase participation, savings rates and ensure that more participants are investing appropriately. They can also be used to engage employees who have been with the company longer and who previously elected not to participate and encourage them to save more for their own retirement.
Any of these programs should be utilized in conjunction with a good participant education program that is more in-depth than just offering generic retirement calculators on the plan's website. Sponsors should also be aware of the demographics of their participants and what their retirement planning goals and concerns are. These will typically drive participant behaviors and sponsors should attempt to have those behaviors driven by educated decisions and not by fear or ignorance.