Advisers and employers have embraced auto enrollment over the last several years as they have looked to help their clients and employees save for a successful retirement. A "successful" retirement is defined as a 401(k) account balance large enough that when combined with Social Security benefits, provides an income replacement rate of 80%.
As employers have rolled out their auto enrollment to employees they have tended to start at 3%. Employers traditionally have used 3% as the default percentage because employers were afraid of starting at a too-high percentage. While this helped engage employees in the plan, it did not alleviate the issue of retirement income adequacy.
With the retirement industry focusing more attention on retirement income adequacy, attention is given to plan features like auto enrollment and the appropriate rate. Employers and their advisers will need to start discussing the right default percentage to help employees achieve retirement income adequacy.
Employers will have to consider if raising the default rate to, say, 6% will increase the opt-out rate by employees or if it will remain the same or decrease. Studies, such as one from the Employee Benefit Research Institute, have shown that increasing the default rate to 6% has had little effect on the opt-out rate.
Another plan feature that will get more attention is the auto-escalation feature in plans. While this feature is not used as much with employers and the impact is not as clear, employers will need to look at their employee demographics to help their employees with solving the retirement income adequacy issue. EBRI's report, "Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans with Automatic Escalation," is at http://tinyurl.com/EBRIautoescalation.
These auto features do not come without some drawbacks. Employers who have used auto-enrollment and auto-increase features tend to have higher participation rates that can drive up the employer costs for matching contributions. Employees who get enrolled and leave shortly afterward can also drive up the time HR has to spend getting these employees paid out. However, this time has been reduced somewhat with the auto cash-out features that plans have been adopting over the last several years.
With the majority of employees still passive when it comes to their contribution rate and investments, employers will need to continue to review their employees' demographics to help their employees save for a successful retirement.
Auto enrollment at an appropriate rate and plan auto escalation are just two ways employers can help employees with retirement savings. It is really smart business sense for employers to help employees plan for a successful retirement, as employees not planning for retirement will need to stay employed longer and drive up other benefit costs, like health care.
The question yet to be answered is will the employees embrace change and start to take an active role in their retirement savings? Time will tell as we progress through the next several years.
Securities offered through LPL Financial, Member FINRA/SIPC.
Ludwig, ChFC, AIF, CRPS, is a financial adviser with LHDretirement and EBA's new retirement columnist. Reach him at email@example.com.
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