Since its inception in 2006, automatic contribution arrangements (automatic enrollment) has steadily grown as a plan provision implemented by Plan Sponsors. Some industry experts have loved the feature, while others have squawked at its effectiveness.
The Truth – Think Strategically
The truth is that when looking at the success of automatic enrollment you have to think strategically. If your primary goal is to increase plan participation in your defined contribution plan, then automatic enrollment is most likely a great solution for you.
Plan Sponsors have seen a 26% increase in participation with automatic enrollment for employees of all ages, and even more impressive is the staggering 56% increase for employees ages 20-24.
Figure 1: Source: Fidelity Investments, Workplace defined contribution data based on more than 20,600 plans and nearly 11.7 million recordkept participants as of 9/30/2011 and do not include tax-exempt accounts or non-qualified plans.
When it comes down to it, automatic enrollment is extremely effective by using human behavior to its advantage. Take for instance the below chart (Figure 2) of organ donor rates in multiple countries. Researchers examined how two very similar countries culturally, Belgium and Netherlands, could have such drastic differences in organ donor rates. The answer was simple – Belgium uses an enrollment form where you check the box to not participate in the donor program and Netherlands utilizes a form where you must check the box to participate. By changing the negative election, the act of not taking action, you can have an impact on the decision making of the individual.
Automatic enrollment uses this method by making each employee make a positive election to not contribute - therefore shifting the non-responders from eligible, but not participating, to participating and contributing (albeit a small amount) towards their retirement.
So, what’s the downside?
What the critics of automatic enrollment will tell you is that the provision actually reduces the average deferral percentage in the plan (6.3% on average for auto plans compared to 6.8% for plans without auto enrollment*) since the automatically enrolled participants typically come in around 3% (see Figure 3). The default deferral rate is not nearly the rate of 10-15% recommended by most financial professionals. It's true that the default deferral rates are not high enough, but at its core, automatic enrollment is excellent at setting the foundation for employees’ retirement savings.
So how do we get employees closer to that 10-15%? Well, that's where automatic escalation (acceleration) comes into play. Stay tuned…
*Source:Principal Financial Group, Analysis of 401(k) Auto Enrollment, 2011