How High Can You Go?
Participants Willing to Accept Higher Default Deferral Rates
It has been said by management that 3% is an unambitious 401(k) plan deferral rate, and it will be more difficult to get employees financially ready for retirement unless they have high average investment returns. It is recommended that most employees should invest closer to 10% or higher, depending on the age they plan to retire. Although 3% has traditionally been the most common default deferral rate used by plans who auto-enroll participants, it appears this rate has begun to change.
Plan sponsors are concerned that if they get too ambitious with the auto-deferral rate, employees will hesitate to participate in the plan, or even, opt out of the plan. It would leave them worse off than they otherwise would have been. Anecdotal evidence, supplemented by survey data, suggests that this fear has been exaggerated.
For example, according to the money-manager newspaper Pensions & Investments, an auto dealership in the Midwest that raised its auto-enroll default deferral to 6% from 3% at the beginning of 2016 reported that its employees didn’t revolt. The company’s maximum deferral rate eligible for a 50% match is 6%, a key factor that might have prevented some employees from objecting.
On a regular basis, large 401(k) record keepers crunch the numbers on deferral rates and other data from all of the accounts they service and publish them. They also look at the impact resulting from such actions as raising the default deferral rates for auto-enrolled participants. Although their data doesn’t always match, they tend to be similar, particularly with respect to trends.
For example, Wells Fargo’s Institutional Retirement and Trust unit determined that there’s no significant difference in auto-enrolled participant opt-out rates, whether the deferral rate is 3% or 6%. (The opt-out rate for both was about 11%.)
Meanwhile, T. Rowe Price reports that in 2011 only 17% of the plans it administered with auto-enrollment had default deferral rates of 6% and above. By 2016, it had risen to 33%. That’s just below the 34% prevalence of the once dominant 3% default deferral rate (used by half of the firm’s clients in 2011). In other words, if those trends have kept up, this year the most popular deferral rate among its clients will be 6%.
At Vanguard, the trends are the same, although in 2016 the percentage of plan sponsors using at least a 6% auto-enroll default deferral rate was only 20%, with 45% still using the traditional 3% rate. Fidelity has reported similar current rates: 18% use 6% deferral rates, and 48% use 3%.
Companies who are comfortable with auto-enrollment tend to extend auto-enrollment beyond just new employees to encourage participation by eligible employees who are not participating (such as if they were hired before auto-enrollment began, or employees opted out after being auto-enrolled in the previous enrollment cycle). Other options that have been seen include auto-increases to deferral rates for active participants whose deferral rate is lower than the default rate.
Through research, it is evident that employers who auto-enroll participants have better luck getting them to accept auto-increases in their deferral rates. Among T. Rowe Price clients, for example, two-thirds of participants in plans with an auto-enroll go along with auto-increases in deferral rates. But, when auto-increase formulas are used for participants who weren’t auto-enrolled, only 12% stick with that program.
Remember — auto-enrollment often helps plans pass average deferral percentage (“ADP”) testing because the average deferral rate for nonhighly compensated employees will increase. Is a higher auto-enrollment deferral rate right for your plan and its participants? Discuss it with your benefits specialist and don’t forget to sweeten the pot with matching contributions.
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