Despite pressure from the financial crisis, 401(k) accounts have grown. A recent study by the Employee Benefit Research Institute found that accounts of consistent 401(k) participants grew 6.8% annually during the five years that included the financial recession, largely due to the expanding role of target-date funds in defined contribution accounts. Benefit advisers and brokers have a large role to play in presenting their employer clients with the pros and cons of 401(k) strategies, such as automatic enrollment and target-date features.


“We keep finding incredible persistence that if you have somebody automatically enroll and place them in a target-date fund on day one, they will typically stay there," says Jack VanDerhei, EBRI research director and co-author of the study.

 

Speaking directly to benefit advisers, VanDerhei recommends, “if you’re dealing with a client who either has automatic enrollment or has decided to switch to automatic enrollment that you will need to be very well-versed in target-date funds and which ones will best for that employer’s participants." 

 

He cautions that if the employer client does not utilize automatic enrollment, but includes target-date funds in the list of options for employees, “it doesn’t seem likely that there will be anywhere near the critical mass of assets that will be produced on the automatic enrollment plans.”

Automatic enrollment can substantially increase plan participation among low-income workers, young workers and minorities — demographics that employers most struggle to engage with their defined contribution plans. According to 2014 How America Saves research from Vanguard, employees who joined their plan through automatic enrollment had an overall participation rate of 82%, compared with a participation rate of 65% for employees who joined through voluntary enrollment.

Vanguard research also supported EBRI’s findings in that target-date funds can dramatically improve portfolio diversification compared with participants making choices on their own. Vanguard anticipates that with the growing use of target-date funds, 58% of all participants and 80% of new plan entrants will be entirely invested in a professionally managed option by 2018.

On the downside, if employers offer an employer contribution match and they successfully increase participation numbers, then the employer's cost of that match will also increase. VanDerhei reminds benefit advisers and employers that it is always a tradeoff between how much more an employer is willing to spend matching contribution rates and how willing they are to increase participation rates.

“The data confirm the continuing important role of target-date funds in 401(k) plans, revealing that a substantial core of consistent 401(k) participants who held at least some target-date fund assets in their account before the financial crisis, still did so at year-end 2012,” says VanDerhei. “At year-end 2012, nearly one-third of those holding any target-date fund assets invested all of their 401(k) balances in target-date funds.” Employer and worker contributions, investment returns, withdrawals and loans all contributed to the increase in account balances, according to the new study by EBRI and the Investment Company Institute.

Auto-escalation considerations

 

For new enrollees into a 401(k) plan who especially desire a decent return in retirement, VanDerhei recommends around 15% total contribution rates between the employer and employee, but recognizes these rates may be too high for some employers.

In that case, VanDerhei acknowledges that most automatic enrollment features start out at a lower combined contribution level of 3%-6% and employ auto-escalation features to increase that contribution level by 1% per year until it reaches the desired level for employers and their participants. 

Vanguard recommends a total contribution rate of 12%-15%, including both employee and employer contributions. The researchers found that while 69% of auto-enrollment plans increased their participants’ contribution rate annually, that meant 29% did not. Furthermore, while 65% of auto-enrollment plans automatically escalate participants’ contribution rate, they default them far short of ideal levels, at 3% or less.

Even though 401(k) participants experienced a 34.7% drop in their average account balance in 2008, these consistent account holders rebounded from the financial doldrums at a compound average annual growth rate of 6.8% from year-end 2007 to year-end 2012. At the end of 2012, the average account balance of the consistent participants was 67% higher than the average account balance among all participants in the EBRI/ICI 401(k) database. Further, the consistent group’s median balance increased at a compound annual average growth rate of 11.9% over the period, to $49,814 at year-end 2012 — almost three times the median balance across all participants at year-end 2012.

“The research highlights that contributing and investing in a 401(k) plan consistently results in higher average account balances than the average balance for all plan participants,” says Sarah Holden, ICI’s senior director of retirement and investor research and co-author of the study.  

The new study looked at the accounts of about 7.5 million consistent participants among the 24 million participant accounts in the EBRI/ICI 401(k) database.


 

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