The Pension Protection Act of 2006 was designed to shore up our private pension system. The law included a key provision, auto-enrollment, to encourage wider participation in company sponsored 401(k) plans. Under the law, companies are allowed to automatically enroll their employees in their retirement plan instead of having them sign up on their own. We believe this was initially a good idea in a country where most aren’t saving enough towards their retirement. Today, employers who offer auto-enrollment report participation rates above 85% compared to 67% for those plans without auto-enrollment, according to Aon Hewitt, a human resources consulting and outsourcing company.
However, with auto-enrollment we are seeing a disappointing trend develop - the dreaded unintended consequence of new legislation. Even though participation rates have increased, the average savings rate per plan participant has actually declined. Vanguard Group, Inc. says that average contributions rates in the plans they administer has fallen from 7.3% in 2006 to 6.8% in 2010. Fidelity Investments has seen a similar trend with average deferral rates falling to 8.2% in 2010 from 8.9% in 2006.
Apparently, most companies offering an auto-enrollment feature have set the automatic deferral rate at 3% or less. Vanguard estimates that about one-half the decline they’ve seen in deferral rates can be attributed to the adoption of auto-enrollment. Because of inertia, most plan participants are not taking action to increase their deferral rate after it is automatically set up for them. Prior to adopting auto-enrollment, the majority of plan participants selected a higher salary-deferral rate. Research has shown that when left to their own devices participants typically elect to defer 5% to 10% of their pay.
The auto-enrollment feature is still a good idea, but it needs to be accompanied by better education for employees about the importance of saving for their retirement. We also believe that an auto-enrollment feature should be accompanied by an automatic-escalation feature. With this, each year an additional 1% or possibly more would automatically be deferred into the plan from the employees pay (unless an employee opts out). Thus, over time an employee would reach the maximum deferral limits their plan allows and better secure their financial future.