What’s Wrong with Automatic Enrollment?
Automatic enrollment has long been touted — and proven — to be an effective way to overcome retirement savings inertia in 401(k) plans. But these days automatic enrollment plan design seems to be suffering from its own inertia.
For all the good press and positive results that automatic enrollment gets, one might well expect that every plan would embrace it. And yet today, nearly a decade after the passage of the Pension Protection Act, many still don’t. What’s wrong with automatic enrollment?
Everybody doesn’t do it.
Only the most naïve industry professional ever assumed that the Pension Protection Act of 2006, even with all its incentives and encouragement (and not a few barrier removals) would transform a voluntary savings system into something that all employers everywhere would feel comfortable — or would be able to afford — automatically enrolling every eligible worker.
And yet, more than a decade later, only about two-thirds of the largest employers have embraced automatic enrollment – and only about a quarter of the smallest programs, according to PLANSPONSOR’s 2017 DC survey. Oh, you see numbers that suggest the adoption rate is higher, but those surveys tend to skewer toward larger programs, where — as the numbers above indicate — automatic enrollment is much more common.
There are legitimate concerns, mind you. Anecdotally many plan sponsors — particularly small plan sponsors — are simply unwilling to impose another financial “draw” on their workers’ paychecks, and most will tell you that they have had those “you need to participate” conversations with their workers, only to have them decline. Moreover, the costs of an employer match when you’re talking about taking participation from a 70% (or thereabouts) level to 95% or higher can be significant.
For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%.
On the workforce management front, it’s worth noting that there are surveys that show that American workers are increasingly delaying retirement (or think they will be able to) due to concerns about retirement finances. Delayed retirements may also reduce the employer’s ability to hire new employees, reducing the flow of new ideas and talent into the organization.
But even when the plan includes automatic enrollment…
There’s a fault with the default.
While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today — as it was before the PPA — is 3%. There is some interesting history on how that 3% rate originally came to be, but the reality today is that it has been chosen because it is seen as a rate that is small enough that participants won’t be willing to go in and opt-out – and, after the PPA, we have some law to sanction that as a target.
That said, nobody thinks 3% will be “enough” — neither to maximize the employer match in most plans, nor certainly to allow workers to accumulate sufficient funds for retirement. That wouldn’t be so bad — it’s a starting point, after all — except that…
The contribution rate is set — and never “reset.”
The authors of PPA’s automatic enrollment safe harbor knew that the 3% default wouldn’t be “enough,” and they had the wisdom to include a provision that called for an automatic “escalation” of that contribution rate — 1% a year (though, weirdly, they included a cap of 10% in the law). Plan sponsors — for many of the reasons that have slowed the adoption of automatic enrollment — have been even slower to embrace automatic escalation. The PLANSPONSOR DC Survey found that only about a third (35.7%) of the largest plan sponsors automatically escalate contributions unless the participant opts out (about the same amount allow the participants to choose to automatically escalate). However, once again smaller plan sponsors are significantly less likely to embrace this plan design.
But even then…
Only the newly hired are automatically enrolled.
For years now, the standard — even among employers who embrace automatic enrollment — is to extend it only to new hires — we’re talking only about a third of plans extend this to other than new hires. The rationale is that existing workers have had their opportunity — and in all likelihood many opportunities — to participate in the plan. Moreover, while the PPA doesn’t mandate going back to older workers, plan sponsors desirous of those safe harbor protections either have to, or have to be able to establish that they have.
Regardless of safe harbor concerns, it’s hard to imagine that plan sponsors who have cared enough to embrace automatic enrollment aren’t just as concerned about the retirement well-being of their more tenured workforce as they are about those recent hires.
However, even among the newly hired, some may have previously participated in another plan — and at a higher contribution rate. Automatically enrolling them certainly removes one of those “first day” new employee hassles — but may not be doing them any favors in terms of their retirement savings.
As with the default contribution rate, surveys have found positive movement on this front in recent years, particularly at the point of provider conversions (amongst a series of other plan changes). Indeed, a small, but growing number of plans are…
Giving workers a second chance.
There’s a new-ish concept called reenrollment. Initially, it was a means by which plans could, at the point of conversion to a new platform, “reenroll” participants into a newly selected default investment fund, generally a balanced or target-date fund that had been chosen as the plan’s qualified default investment alternative, or QDIA (they were generally given time to opt-out of that decision before conversion). More recently, it has been expanded to basically treat all eligible non-participants as new hires — auto-enrolling them in the plan, and in some cases, reenrolling at the default rate if they happened to be contributing below that rate.
That said, this approach is not only new-ish, but not very common. Even among the largest plans (more than $1 billion in assets) responding to the PLANSPONSOR DC Survey, more than 86% don’t do any part of this.
There are, of course, good things with automatic enrollment, mostly that there are today many participants saving at 3% (and a match) who weren’t saving anything previously.
So, what’s wrong with automatic enrollment? Well, there are some participants who were auto-enrolled at 3% who would probably have enrolled at a higher rate, and some who change employers and are being auto-enrolled at a “start over” rate. In most cases the default contribution rate isn’t changed (by the employer, and certainly not by the participant), and auto-enrollment is still (mostly) limited to new hires.
What’s wrong with automatic enrollment? Nothing, once we remember that it’s (only) an effective starting point — and one that, like most good decisions, requires some follow-up.