‘Staying’ Power

  For years now, I’ve been saying that the only thing wrong with the 401(k) system is that there aren’t enough of them. And to be fair, the past several years have largely validated that view.

Indeed, Vanguard’s latest How America Saves report paints what is, on the surface anyway, a remarkably encouraging picture. Participation rates among eligible workers are near record highs. Contribution rates rose — 45% of participants increased their savings rate in 2025, contributing to an average savings rate of 12.1%, an all-time high. Professionally managed investments dominate participant portfolios. Most investors ignored market volatility entirely — and, doubtless as a result of all that — account balances reached new highs.

Yes, after decades spent worrying about employees failing to enroll, hunkering down in stable value funds, or panic-trading during downturns, the modern defined contribution system increasingly appears to be functioning as designed — or, as Vanguard labels it — a “quiet retirement revolution.”

But another recent study suggests that the industry may be misunderstanding what “success” actually looks like.

Morningstar’s paper, Access, Auto-Enrollment, and Accumulation: A Simulation of Universal Retirement Plan Coverage, modeled the impact of automatically enrolling workers without retirement plan access into a federally administered savings arrangement. The results are impressive. Tens of millions of additional workers could enter the retirement system. Hundreds of billions — perhaps more than a trillion dollars — in additional retirement savings could accumulate over time.

But buried deeper in the analysis is a more revealing point — the real breakthrough in retirement outcomes may not be access.

ad space

It may be continuity.

The Vanguard report and the Morningstar study actually tell a surprisingly consistent story when viewed together. While Vanguard shows a system increasingly optimized around automation and default behaviors, Morningstar shows that the outcomes of even the best-designed system can be undermined if workers cannot remain continuously connected to savings long enough for compounding to matter.

And that matters. Big time. Particularly in view of the workers most vulnerable to those employment “disconnects;” lower-paid, minorities, women, the young…

Let’s face it. The retirement industry has spent much of the last two decades trying to solve the participation problem. In many respects, it has succeeded. Automatic enrollment, automatic escalation, target-date funds, managed accounts, and payroll deduction have fundamentally changed participant behavior — or perhaps more accurately, reduced the need for participant behavior altogether.

More recently, the focus has shifted toward expanding access to workplace programs — reinforcing how strongly availability, combined with automation, improves savings outcomes — even for workers with modest incomes.

But the Morningstar analysis highlights that workers with long periods of uninterrupted participation saw dramatically larger projected gains than workers with shorter or fragmented savings histories. Automatic enrollment helped. Higher default contribution rates helped somewhat. But it was remaining attached to the system through job changes, financial emergencies, and career transitions — that mattered more than almost anything else. “Workers with 10+ years of sustained participation could see 67% to 125% higher retirement wealth under auto‑enrollment scenarios,” according to the report.

ad space

Leakage remains stubbornly high. The number, if not the amount, of hardship withdrawals continues to rise. Cash-outs during job transitions remain common — most particularly in situations where a participant loan is outstanding. Vanguard’s data itself hints at this tension: record balances existing alongside increasing hardship withdrawals. The system has become exceptionally good at getting money into retirement accounts — but still struggles to keep it there when life intervenes.

In other words, the retirement system may be healthier than it has ever been structurally — while on an individual basis many retirement savers remain financially fragile.

That tension becomes even more apparent when looking at which workers benefit most from expanded access proposals. Morningstar found the largest projected gains among lower-income households, younger workers, single women, Hispanic workers, and Black workers — populations historically less likely to have access to employer-sponsored plans.

For years, the policy focus has centered on access: state auto-IRAs, SECURE Act mandates, automatic enrollment requirements, and proposals to expand coverage. Those initiatives matter. They clearly move the needle — and will continue to do so.

But the future success of the defined contribution system may depend less on whether workers can open an account — and more on whether they can stay invested long enough for the system to work as intended.

• Nevin E. Adams, JD

(Not) Standing Still

A recent headline screamed that 401(k) savings rates have “stagnated” – but that’s missing the point. Several of them, actually.

“Stagnated” in this case apparently means that the average savings rate in 2018 — both employee and employer contributions — was 10.6%, roughly the same as the 10.4% rate reported in the survey in 2004. The point seems to be that, despite roughly a decade of automatic enrollment and other plan design enhancements, Americans aren’t saving any more.

That’s a perfectly obvious point to draw from those two datapoints – in this case from the recent 2019 How America Saves report from Vanguard which, while it only covers plans recordkept by Vanguard, the experience of 1,900 plans and 5 million participants in the survey always provides some interesting insights.

First a couple of basics; what do you suppose the odds are that we have the same plans (and participants) in the 2004 and 2019 surveys? Exactly. So, while it may not be apples to oranges, it’s clearly not pure apples to apples, either. The Vanguard authors themselves at one point acknowledge that there has been an impact to the report averages due to bringing on new plans with lower account balances. Secondly – and I’ve written about this previously – averages are mathematically simple, but can gloss over individual details.

There is, however, much more going on behind the scenes than the average conveys[i]. The reality is that automatic enrollment, while it boosts participation, actually – initially – depresses average savings rates. Why? Because while it generally lifts the participation rate from 70% or so to 90% or so, at the same time it “creates” a whole new group of people saving at a default rate (typically 3%)[ii], whereas those who signed up voluntarily save at rates more than double that. Consequently, you might well expect that a decade of automatic enrollment plan designs might have done good things for participation, they might well have depressed savings rates – and yet, they haven’t.

Some of that can be attributed to improvements in those automatic designs; in 2018, echoing results from the Plan Sponsor Council of America’s 61st Annual Survey of Profit Sharing and 401(k) Plans, slightly more than half of plans chose a default rate of 4% or higher, whereas in 2008 only about a quarter (27%) of plans did. The report also notes that in 2018 23% of plans chose a default rate of 6% or more – more than double the percentage that did so in 2009. And while it has long been the “norm” to apply automatic enrollment provisions to new hires only, the newest Vanguard report finds that it has now been applied to all non-participants in half the plans.

Better still, two-thirds of the plans with automatic enrollment have now implemented automatic annual deferral rate increases, and as of 2018 that has served to narrow the spread between deferral rates for participants in voluntary enrollment plans and those with automatic enrollment to just 0.4 percentage points!

Not that there isn’t room for “improvement”; just one-in-five had a deferral rate of 10% or higher in 2018, and – to the point above, 3 in 10 had a deferral rate of less than 4%. Moreover, only 13% of participants capped out at the 402(g) limit ($18,500), and in plans that allow catch-up contributions for those aged 50 and more, only 15% took advantage of that opportunity in 2018. And – even among the highest paid workers, 6% of those eligible aren’t (yet) taking advantage of that opportunity.

The dictionary defines “stagnant” as “showing no activity; dull and sluggish.” Well, while one number may make it seem that retirement savings has been standing still, the reality is quite different – and not at all "stagnant". 

---

[i] To their credit, the Vanguard report authors take pains in the space of the 112-page report to not only provide median, as well as average figures, but to break data down by tenure, salary, and in some cases, age, as well as for participants who have been consistently in their database over a period of time.

• [ii] The Vanguard report notes that even among individuals earning less than $30,000 in plans with automatic enrollment have a participation rate more than double that of those in plans with voluntary enrollment.

"Checks" and Balances

In about a month, the IRS will announce the new contribution and benefit limits for 2018 – and that could be good news even for those who don’t bump against those thresholds.

These are limits that are adjusted for inflation, after all – designed to help retirement savings (and benefits) keep pace with increases in the cost of living. In other words, if today you could only defer on a pre-tax basis that same $7,000 that highly compensated workers were permitted in 1986 – well, let’s just say that you’d lose a lot of purchasing power in retirement.

But since industry surveys suggest that “only” about 9%-12% currently contribute to the maximum levels, one might well wonder if raising the current limits matters. Indeed, one of the comments you hear frequently from those who want to do away with the current retirement system is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, who perhaps don’t need the encouragement to save. Certainly from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Drawing on the actual account balance data from the EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), the nonpartisan Employee Benefit Research Institute has found that those ratios were relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000. (See chart.) In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes – and not “upside down.”

And yet, according to Vanguard’s How America Saves 2017, only about a third of workers making more than $100,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the rich, why aren’t more maxing out?

Arguably, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Sections 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that – to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

Those who look only at the external contribution dollar limits of the current tax incentives generally gloss over the reality of the benefit/contribution limits and nondiscrimination test requirements at play inside the plan – and yet surely those limits are working to “bound in” the contributions of individuals who would surely like to put more aside, if the combination of laws and limits allowed.

One need only look back to the impact that the Tax Reform Act of 1986 had on retirement plan formation following the imposition of strict and significantly lower contribution limits – as well as a dramatic reduction in the rate of cost-of-living adjustments to those limits – to appreciate the relief that came in 2001 with EGTRRA.

Anyone who has ever had a conversation with a business owner – particularly a small business owner – about establishing or maintaining a workplace retirement plan knows how important it is that those decision-makers have “skin in the game.”

While we don’t yet know what the limits for 2018 will be, gradually increasing the limits of these programs to keep pace with inflation helps assure that these programs will be retained and supported by those who, as a result, continue to have a shared interest in their success.

And that’s good news for all of us.

- Nevin E. Adams, JD