Missing the Mark

 A recent survey posed an intriguing question: Why are employees not participating in their 401(k)s? The answer(s) were jaw-dropping.

Now, I’ve previously expressed skepticism regarding workers’ perception of things like retirement savings needs, much less retirement savings balances, and over the years there has been plenty of anecdotal evidence to suggest that workers think they have a pension, despite plenty of actual data to indicate that’s a misguided fantasy. In sum, it seems that many, if not most, workers have a pretty distorted view of their financial circumstances, certainly as it relates to retirement.

That said, a recent survey by Principal takes that to a whole new level. 

That survey found that more than half — 59% — of workers who were not saving for retirement — thought they WERE saving for retirement. Nearly half (49%) thought they had been automatically enrolled, but nearly as many (41%) thought they had signed up on their own. And three-quarters (77%) said they had started saving as soon as they were eligible for the plan!

And if that wasn’t enough — turns out that while 83% say that they’d start contributing if they received a match ... 78% of those respondents are actually in plans that DO offer a match. Oh, and 70% of those who thought they were contributing (but weren’t) actually thought money was being deducted from their paychecks for that purpose.

Oy vey!

Some of this confusion might be a consequence of turnover — 40% said they had had more than one job in the past five years, after all. Let’s face it, it’s easy to lose track of things like benefit enrollment when you’ve changed jobs that often (or to assume that just because you were saving at your old job transferred to the new one). Some can doubtless be attributed to the industry’s growing reliance on automatic features — both by plan sponsors and workers — that lessens or eliminates the traditional need to be attentive to such things. Ultimately, a big part of it is likely nothing more than a combination of both the complexity of the process and the “distractions” of daily life.   

Now, I’m not quite sure how to remedy the passivity of those relying on their employer to sign them up, much less the myopia of individuals who aren’t even paying attention to the deductions on their paystubs. Maybe we should start mailing out statements to non-participants that showed a $0.00 balance (in red) that confirms their lack of an account — though my guess is they’d just file it away. 

Whatever the reason(s), this survey suggests that messages about the importance of saving for retirement — much less saving more — are likely going right over the heads of people who seem to think they already are. 

And in that sense, this survey also suggests that OUR assumptions about the efficacy and impact of our communications in inspiring better efforts — could be missing the mark as well.

- Nevin E. Adams, JD 

The Limits of Behavioral Finance?

  It’s long been noted that inertia is a powerful force regarding behavioral finance and automatic enrollment — but it may have limits, according to a new study.

Coverage of the report — titled “Smaller than We Thought?  The Effect of Automatic Savings Policies” — focused on how job change undermines retirement savings — both because of vesting, as well as the effectiveness of automatic enrollment, and more specifically auto-escalation, since those mechanisms tend to reset with the change in employers (and payroll).   

Don’t get me wrong. The report states quite clearly that these automatic mechanisms provide a positive result — the authors comment only that it’s perhaps not quite as positive as most think.  Their solution — give people less access to these monies before retirement, and require savings, rather than permitting an opt-out. 

From a pure mathematical stance, there’s little argument there — making people save and prohibiting pre-retirement access to those funds certainly benefits retirement savings, though it also exacts a financial toll in the here and now.

There’s little to be done about job change — which, as I’ve noted before, isn’t really all that different today than it was several decades back. And it should come as no surprise that folks that have been accustomed to automatically being defaulted[i] into saving at employer #1 will readily come to rely on that convenience at employer No. 2, if the option is available, and even if it resets their rate of savings. 

Indeed, we’ve long embraced a working assumption that automatic enrollment takes participation rates of 65%-70% and turns them into 90%.  Said another way, only about 1 in 10 take the time/energy to opt-out of automatic enrollment. 

Opt-Out Observations

That said, what caught my eye here was what turns out to be an extraordinarily high rate of opt-out when it comes to automatic escalation.  Among the plans/participants studied[ii], more than half - 57% - opted OUT of automatic escalation the very first time it came up.  And it gets worse as time progresses; while on average, the acceptance rate of the auto escalation default is 43% on the first escalation date[iii], it slips to 36% on the second date, and 29% on the third date. 

Admittedly that’s higher than previous research suggests — in fact, the researchers acknowledge that in the Vanguard “universe”, the acceptance rate of an auto-escalation default is 63%, 63%, and 60% after one, two and three years of tenure — though even that was significantly below the 85% found by in a 2013 study by Benartzi, Peleg, and Thaler. 

Those differences can be attributed to different employers, different employee populations, even different periods of time during which the assessments are made.  Just as significantly, we don’t know anything about their financial situations, the rate of deferral they were defaulted in at, or why they opted out. 

That said, the opt-out rates struck me as higher than most might be led to expect — suggesting that while inertia can be a powerful force, it’s not without its limits.

• Nevin E. Adams, JD

 

[i] The 67^th Annual Survey of Profit-Sharing and 401(k) Plans by the Plan Sponsor Council of America found that 64% of surveyed plans use an automatic enrollment feature (74.3% among larger plans).  That same survey found that more than three-quarters of the plans that use automatic enrollment also employ contribution acceleration.

[ii] The study focuses on nine firms that, sometime between 2005 and 2011, introduced either (1) automatic enrollment on its own, (2) default auto-escalation in a 401(k) plan where automatic enrollment was already present, or (3) automatic enrollment and default auto escalation simultaneously. The automatic policies applied only to employees hired from a certain date onward, so they identified their effect by comparing 62,430 employees hired in the year after the policy introductions to 55,937 employees hired in the year before the policy introductions.

[iii] Opt-out rates that, as it turns out, aren’t very different from that reported from most of the state-run IRAs.

3 Ways to Get Your Automatic Enrollment Plan Out of its Rut

Inertia is a powerful force in nature, and in human behavior. Even the most proactive and engaged plan designs (and plan designers) can, over time, slide from being in a groove to being in a rut.

Here are three ways to reinvigorate automatic plan designs.

1. Auto-enroll all Eligible Participants

Over the past decade a growing number of plans have embraced automatic enrollment, in the process not only simplifying and streamlining the process, but also expanding the number of individuals who are saving for retirement. These days, new hires, regardless of their age, are routinely defaulted not only into the plan itself, but also into some type of qualified default investment alternative, whether it be a managed account, target-date fund, or balanced fund.

However, those who have been employed for some time are often not accorded that convenience. Instead, perhaps because they are presumed to have previously made a decision not to participate, it is assumed that if they were to have changed their mind, or have changed circumstances, they would take it upon themselves to enroll on their own. Or perhaps in some cases, the very success of automatic enrollment gives pause because adding all those existing workers to the plan (along with matching employer contributions) brings with it financial consequences.

Regardless, and certainly if the plan has had automatic enrollment in place for new hires for a time, the better way, it seems to me, is to offer the same opportunity to all eligible workers.

2. Auto-escalate Employee Contributions

While there is evidence that this is changing, for nearly as long as there have been automatic enrollment plans (and it goes back to the early 1980s at least), the default contribution rate has been 3%. Now, regardless of how that became the default of record, eventually becoming ensconced in the auto-enroll safe harbor of the Pension Protection Act of 2006, there’s one thing on which nearly everyone will agree: a 3% rate of savings is almost certainly not enough.

Having embraced the automatic enrollment design (and, with luck, extended that to all eligible workers), you can make automatic enrollment better by helping participants save more by automatically increasing their rate of savings by 1% or 2% per year. There is some evidence that, with a three- to four-year lag, plans that have adopted automatic enrollment do move on to add auto-escalation as an option. But think of the missed retirement savings and security in the interim.

3. Reenroll at Least Once – and Maybe More

A common practice in moving from one recordkeeper to another has been to “map” similar fund options from the old platform to comparable (if not identical) funds on the new platform. In recent years, this mapping process has been improved by not just copying over existing fund choices (which may not be optimal, and may not have been reviewed or updated in a long time), but by reenrolling everybody in the plan to an age-appropriate asset allocation fund, such as a target-date fund.

Reenrollment has some logistical and communications issues, of course. It is a bit like moving every year, and if not nearly as complicated (or costly) as actually changing recordkeepers, it can be challenging to explain, particularly to participants who themselves have slipped into a rut. And you might well be advised to leave participants who have voluntarily elected to opt out of the reenrollment once (or twice) where they elected to be.

But if as a plan sponsor/fiduciary you have liability for the fund choices participants have made (and, outside of a 404(c) safe harbor, you do), wouldn’t you want to take advantage of the opportunity to help participants invest their retirement savings in a fund that is overseen by professionals, rebalanced on a regular basis and invested with some sensitivity to their retirement timing?

Or, as the foregoing suggest, at least have a process in place that not only reminds them of the advantages – but nudges them toward a better result.

- Nevin E. Adams, JD

See also:

• Is Automatic Enrollment Still Going… or Slowing?
• 3 Things You Should Know About Automatic Enrollment
• Are Auto Engagements Over?

"Choice" Architecture - for Plan Sponsors

In recent years, the notion that the ways in which choices are presented to individuals — known as “choice architecture” — can influence their decisions, has been widely embraced.

Well before the advent of the Pension Protection Act of 2006, the retirement plan industry had acknowledged the positive influences of those behavioral finance techniques on overcoming, or at least countering, certain human behaviors.

Based on the evidence of several decades of adoption, we know that automatic enrollment — even with the ability to opt out — transforms voluntary participation rates of roughly 70% to near-unanimous participation. And yet, even with the structure and sanction of the PPA, today fewer than half of the roughly 7,000 plan sponsor respondents to the 2013 PLANSPONSOR DC Survey have implemented that design (large plans being significantly more likely to do so than smaller programs).

Even plan sponsors that have adopted automatic enrollment tend to do so with a default deferral rate that is almost assuredly too low to assure success for anyone (typically 3%, the rate specified in the PPA safe harbor) — which might not be so bad, but for the lagging implementation of contribution rate acceleration. The PLANSPONSOR survey found that only about a quarter (26.9%) did so. Even among the largest plans (more than $1 billion in assets), only about half (54.2%) “auto accelerate.”

And then there’s the inclination to automatically enroll only new hires. Industry surveys suggest that only about a third of auto-enrolling plans extend that to current workers.

Setting aside for a minute the reality that not every workforce is suited for the administrative rigor of automatic enrollment — and that many smaller employers have in place safe harbor plans that serve to automatically “enroll” workers via that safe harbor contribution — there are real, tangible, and often unacknowledged employer costs to undertaking automatic enrollment.  

Specifically, the transformative participation effects cited earlier frequently carry significant additional costs in terms of the employer match. The math of switching to a so-called “stretch match” — which seeks to ameliorate the cost issue by altering the rate of match (say by matching 25 cents on the dollar up to 12% of pay, rather than 50 cents on the dollar up to 6%) — may work, but workforces that have been accustomed to the latter formula will almost certainly see the former as a reduction in benefits.

Similarly, while PLANSPONSOR’s 2013 DC Survey found that three-quarters of the roughly 7,000 plan sponsor respondents said that it was either very important (41.1%) or important (36.8%) that their plan provide retirement income solutions to participants. Yet most do not offer any income-oriented products/services in their plan. That’s a disconnect, to be sure. But in view of expanding fiduciary concerns in selecting and monitoring those offerings, is it irrational?

Over the years, a lot of thought has gone into plan design features — choice architecture — that can help participants make better decisions (or, in some cases to make better decisions on their behalf). But policymakers and regulators, and the academics who sometimes advise them, tend to forget that the employer’s decision to keep, and to offer these programs in the first place, is also a choice.

A choice that the rules, regulations and limits bounding these programs don’t always encourage.

- Nevin E. Adams, JD