Participants Must Be ‘Nudged’ Toward Higher Savings Rates

New research by Morningstar suggests plan sponsors may benefit from increasing default savings rates, relying on opt-out auto escalation features, and stretching the employer match.

Sponsors of defined contribution (DC) plans spend plenty of time and effort on strategies to boost participation rates; however, high participation levels alone don’t necessarily indicate a healthy plan.

According to research by Morningstar, about half of DC plans offering automatic enrollment place their new participants at a “low” and “inadequate” savings rate of 3%.

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The firm’s latest research paper surveys thousands of participants and explores different ways to increase deferrals. The firm points out that participants accepted the default savings rate at roughly the same level, whether it was set at 3% or 12%. Moreover, those who choose their own savings level tended to opt for higher rates over the plan sponsor’s chosen default. Morningstar believes the default rate may even serve as a mental “anchor,” leading employees to incorrectly visualize where the acceptable starting point is. The firm concludes, “The results strongly suggest that increasing default savings rates is likely the simplest and most effective way to get participants to save more for retirement.”

The firm finds that 68% of plans recordkept by T. Rowe Price offer auto-escalation as an opt-in feature, but only 11% of participants choose to use this feature. Moreover, these features could be undermined by employee turnover, especially when a worker changes employers and finds they have been defaulted into a lower savings rate. Morningstar finds that the median employee turnover rate is four years for all American workers, and less than three years for those younger than 34. Unfortunately, many employees don’t carry over their previous savings rate.

The conclusion is that plan sponsors may be able to benefit from “nudging” employees toward better behaviors. This could include utilizing higher-than-average default rates, utilizing re-enrollment for current employees, or applying higher auto-escalation rates via an opt-out feature. Effective communication must also be implemented to minimize employee push back. Morningstar also notes that plan sponsors “concerned about the potential additional costs associated with higher levels of participation (and higher savings rates) could consider stretching the match to a higher level and/or changing the match rate to a discretionary formula, i.e., one that can be adjusted based on actual participant savings levels/costs.”

The employer match could be an effective incentive to get participants to save more. The paper suggests that instead of offering a 100% match on the first 3% saved, an employer could offer a 50% match on the first 6% saved, “thereby increasing the contribution rate at no cost to the employer.”

Moreover, Morningstar finds that communication and advice could also have a positive effect on savings rates. According to its research, 90% of participants who engaged with in-plan solutions such as robo-advice increased savings rates by about 2%. Morningstar says, “Advice solution providers should be aggressive when providing savings guidance to participants and can include recommendations on saving, investing, and when to retire.” 

ICI Measures Adequate Income Replacement

Research findings show Social Security benefits and retirement income from employer-sponsored retirement plans, annuities, and IRAs together provide substantial income for U.S. retirees.

Most American workers maintain or increase their spendable income after claiming Social Security, according to a new analysis of tax data by Investment Company Institute economists Peter Brady and Steven Bass.

Economists Jessica Holland and Kevin Pierce of the Statistics of Income (SOI) Division of the Internal Revenue Service (IRS) also contributed to the new analysis, ICI says. The effort involved researchers analyzing tax data from 1999 to 2010, finding that the median worker had replaced 103% of spendable income after claiming Social Security.

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Findings show Social Security benefits and retirement income from employer-sponsored retirement plans, annuities, and individual retirement accounts (IRAs) together provide substantial income for U.S. retirees. As expected, the analysis contends Social Security is “relatively more important for lower-income individuals,” while private retirement income sources matter more to higher-income individuals.

“Those in the middle receive a similar amount of income from both sources,” ICI finds.

“The vast majority of workers we analyzed reported retirement resources other than Social Security,” Brady observes. “Indeed, 89% of individuals held or drew income from employer plans, annuities, and IRAs. These results suggest that a much higher share of retirees get income from these sources than reported in government surveys, and adds to the mounting evidence that household survey data understate retiree income.”

NEXT: Discretionary income also increases 

ICI says that by “looking at what tax filers, employers, and financial institutions actually report to the IRS, we are able to paint a more accurate picture.”

Findings show, of the 89% of individuals who had non-Social Security retirement resources, the vast majority (81%) received income, either directly or through a spouse, from employer plans, annuities, or IRAs.

“Another 8% had evidence of these resources—a Form 1099-R (reporting a rollover or other retirement account transaction that did not generate income), a Form 5498 (indicating IRA ownership), or both—but were not yet drawing on them,” ICI reports.

The authors of the analysis stress that their research “compares taxpayers’ spendable income, as reported on their tax returns and on information returns provided to the IRS, three years after they claim Social Security with their spendable income the year before they claimed.”

As such, the 103% replacement rate measures for the median taxpayer “indicates that spendable income rose for more than half of taxpayers.” Median replacement rates three years after claiming were higher for individuals in the lowest income quintile (123%), ICI finds, “and lower for top earners (95% for the top 1% of the income distribution).”

ICI has prepared a fact sheet describing the research in more detail, available here.

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