Higher Default Auto-Escalation Rates Could Mean Fewer Opt-Outs, Voya Study Shows

As with so many things that behavioral finance has learned by studying human activity around defined contribution plans, new research finds that regarding escalation, defaults matter. 

While DC plan participants can have the option to specify their rate of contribution escalation and the date escalation should begin when enrolling in 401(k) plan that offers those features, Voya Financial found that nearly everyone who enrolls in auto-escalation sticks with the prominently displayed default parameters of a 1% annual escalator after the first year. 

But when designing a successful auto-escalation regime into a 401(k) plan, Voya says plan sponsors could get participants to increase their savings even more by adopting higher default escalators, according to the report “How to auto-escalate your 401(k)” published in February.  

To understand the impact of different auto-escalator settings, researchers Saurbh Bhargava, Rick Mason and Mark Patterson at Carnegie Mellon University and Schlomo Benartzi at UCLA conducted a field experiment where they varied whether an enrollee would see a default escalator of 1% or 2% and whether the start date of escalation was after a year, six months or three months in the plan. 

The researchers randomized the default auto-escalation options displayed to 22,170 new 401(k) enrollees across 398 plans. These plans used an opt-in enrollment process where employees had to choose whether to save and whether they want auto-escalation. 

Voya says this is different from automatic enrollment plans where employees are often automatically assigned escalation features. 

The researchers then observed the escalation choices of enrollees at the time of enrollment and checked in on their savings several months later. 

First, the researchers found that defaults matter, and a majority of the auto-escalation enrollees followed the default escalators and delays.  

In addition, they found that higher default escalators can lead to faster escalation of contribution levels over time. More than half of the employees who encountered the 2% default stuck with that level of escalation. The majority of the remainder switched back to 1%, but still chose to escalate. 

“Critically, the higher default escalator did not meaningfully increase the share of employees initially declining auto escalation,” the report stated. “The combination of more aggressive default escalation increments and no corresponding drop in enrollment suggests that plans could increase saving by increasing the escalation increment to 2%.” 

The study also found that a substantial share of employees were willing to escalate well before 12 months had elapsed. When promoted by the default, 54% of employees appeared willing to escalate in 90 days, and 67% in 180 days. 

“This suggests that, for the majority of employees, the ‘future’ begins within a few months,” the report stated.  

However, researchers found that more aggressive default delays, which led to escalation beginning sooner, modestly reduced escalation enrollment to 18% from 23%. 

Under the SECURE 2.0 Act of 2022, plans launched between 2023 and 2024 must escalate an employee’s contribution rate by 1% annually until it reaches a minimum of 10% or a maximum of 15%, at the discretion of the sponsor. All plans initiated in 2023 or 2024 must have this automatic feature but have until 2025 to implement them. 

Newly created 403(b) plans must also enact the automatic enrollment and escalation features. Employees can opt out of either.  

According to data from Vanguard, plan design features, like an auto-sweep, can empower workers to save at higher amounts. For example, in 2021, 14 plans using Vanguard as a recordkeeper and enrolling more than 9,100 participants, automatically increased low-savings participants to the rate necessary to receive the full employer match.  

Overall, 78% of participants had their deferrals increased, and fewer than one in four participants opted out afterward.   

Voya says there is a need for additional research to help determine the optimal escalation default needed for different types of employees. Personalized default rates can help more employees boost their savings, as well as minimize the number of employees who choose to opt out of escalation. 

“By helping workers get to the right savings rate in less time, we can design auto-escalation processes that help employees be more prepared for retirement, even in a modern labor market where people regularly change jobs,” the report states.  

According to the Bureau of Labor Statistics, the median employee tenure was only 4.3 years for men and 3.8 years for women, as of January 2022.  

Voya says the short tenure means that it is critical to get workers to the right savings rate “sooner rather than later.”