Since the Pension Protection Act of 2006, automatic enrollment and automatic contribution rate increases have become very popular features of 401(k) plan design. In fact, most surveys indicate that about half of 401(k) plans have automatic saving provisions.
While automatic features have helped participation and saving rates, there is concern that low default deferral rates can result in low savings rates. Also, auto enrollment is largely applied only to newly eligible employees, and even though automatic contribution increase provisions are common, they are often available on an opt-in basis.
What steps represent the second generation of automatic features?
Automatically enroll all eligible employees
T. Rowe Price’s Getting Beyond Ordinary: Advances in Automatic Savings Program Design notes that an “enhanced” program would automatically enroll all eligible employees, not just those who are newly eligible. An “advanced” program would periodically enroll non-participating employees.
Automatically increase deferral rates
The Price report suggests that in an enhanced program, an effective approach to increasing participants’ contribution rates is to require them to opt out of automatic increases, as opposed to opting in.
Another new technique is called “auto boost.” In this approach, deferral rates are automatically increased for current participants. Auto-boosting can help raise contribution rates to the basic default level and may maximize any company match.
A combination of auto-boosting and automatic rate increases could certainly help participants reach savings rates that are needed to accumulate comfortable retirement savings amounts.
In an advanced program, the sponsor would periodically reenroll participants who opted out of automatic increases in the past.
Use a QDIA to help diversify
Under an enhanced approach, the sponsor might “reset” participants’ accounts into a QDIA (Qualified Default Investment Alternative) on a one-time, opt-out basis. This could be introduced to those who remain in a stable value default option and/or those who are using only one investment choice or otherwise do not have a well-diversified portfolio.
An advanced program would periodically reset both the participant’s contributions and account balance to the QDIA.
Best practices are suggested
The Defined Contribution Institutional Investment Association (DCIIA) recently released a white paper which, like the T. Rowe Price report, reviewed how automatic provisions can be structured to help participants achieve a better income replacement ratio in retirement. Best Practices When Implementing Auto Features in DC Plans reviewed case studies in which plan sponsors implemented auto features in “more robust” ways.
The review led to suggestions regarding best practices, including:
- Automatically enroll all current employees and future new employees in the plan.
- Establish the initial default deferral rate at a minimum of 6%.
- Implement automatic contribution rate increases of at least 1% or 2%, and set a maximum of no less than 15%.
The DCIIA study is at http://tinyurl.com/DCIIABestPractices.