Persistent Myths About Automatic Features Hurt Retirement Savers

Plan sponsors would be wise to annually pull back into their retirement plans employees who have opted out, according to a report from Capital Group.  

Plan sponsors’ reluctance to use automatic features to bolster participant savings is a risk for plan sponsors because it will leave plan participants with insufficient savings when they reach retirement, says John Doyle, senior vice president and senior retirement strategist at Capital Group.  

There may be no more optimal way for plan sponsors to help boost participants’ retirement savings and strengthen their retirement readiness than by using thoughtful auto-features, he says.  

“If the objective is retirement readiness and getting participants ready for retirement, then automatic features seem to be the best way to do it, but it’s not black and white,” Doyle says. However, “if you do [auto-features] right, it is a really good start to getting people ready, saving for retirement and heading in the right direction.”

Employers should approach auto-features with great deliberation, Doyle wrote in an article for Capital Group titled, “Auto Features: Friend or Foe?” 

A persistent mistake that plan sponsors make is in setting the auto-enrollment contribution floor, Doyle says.   

“If you implement it wrong, meaning you offer too low a default rate, without a means to leverage inertia to get people to save more, they believe they’re saving the right amount and they’ll get to retirement with a very small percentage of what they really need to retire,” he says.

Auto-enrollment allows plan sponsors to automatically deduct elective deferrals from an employee’s wages unless the employee makes an election not to contribute or to contribute a different amount. For plan sponsors that are concerned about the retirement readiness of their employees, “getting them enrolled at the right amount is paramount to that success,” Doyle says.  

“Sometimes the message we send with automatic enrollment is actually as much of a roadblock as not doing it at all, because if you do automatic enrollment at too low a rate then ultimately, you’re sending a message to participants that [they are saving] enough when the truth is it’s not,” he says.

Plan sponsors’ use of automatic enrollment has increased, according to the Plan Sponsor Council of America’s 64^th Annual Survey of Profit Sharing and 401(k) Plans.

The survey found that auto-enrollment and auto-escalation “have made modest gains,” as 62% of plans in 2021 used an auto-enrollment feature. The survey also found that among plan sponsors, last year was the first year when the most common default deferral rate used by employees was 6%, for 32.9% of plans, while the second most common was 3%, for 29% of plans.  

“My goal in writing the article was that there are certain myths out there that seem to perpetuate themselves,” Doyle says, such as “that 3% is a good default rate to get people started, [and] that auto escalation should be capped … those are two things that ultimately I think are holding back the success of auto features in retirement plans.”

Doyle highlights that savings amounts are stake when plan sponsors use a 3% deferral rate. As an example, he uses the median weekly earnings for full-time wage and salary workers in the U.S., $1,037 as of the first quarter of 2022. When extrapolated to an annual pay of $53,924—assuming certain market conditions and 4% average inflation—a 3% contribution rate would accumulate an estimated $1,618 of savings over one year. 

In the example, setting the participant’s age at 40, the individual has at least 25 years to save.

“According to American Funds’ retirement planning calculator, someone looking for 80% of their final annual salary during a 20-year retirement, starting at $53,924, could need to save $1,074,032,” Doyle  wrote. “With a 3% contribution rate, they’re projected to come out of 27 years’ worth of saving with $152,640.” 

Auto-Escalation and Auto-Sweep

Doyle says plan sponsors should have a bit more courage when it comes to using auto-escalation, and that employers often overestimate the risks associated with doing so.

“Automatic escalation is not that controversial because it’s really easy for participants who [don’t] want to save more to opt out,” he says.

Auto-escalation is a feature that automatically increases participants’ contributions at regular intervals by a set amount until a preset threshold is met. At the outset of the use of auto-escalation there was a concern among plan sponsors that those participants who were auto-escalated to save more each year would feel that they were being forced to do so, Doyle says.   

Doyle’s article suggests that plan sponsors should consider setting escalation caps at 15% of pay and let employees decide for themselves if they want to opt out. However, he says that in many cases, it’s unwise for plan sponsors to set a cap for escalations because “the cap is really an artificial barrier to participants being able to save enough for retirement, that’s part of the challenge.”

Automatic sweep is an emerging auto-feature that some plan sponsors use to, at certain intervals, re-enroll participants who have opted out of the plan.

Doyle suggests that plan sponsors use a yearly auto-sweep timeline, because it’s simpler and less confusing to participants and administrators.

“Do it along with open enrollment for the other benefits, because [workers are] already thinking about their benefits,” he says. “Automatically enroll them in the plan every year and if they want to opt out, they have that opportunity.”

With auto-sweep, plan sponsors have a weighty decision that can affect participants for many years into the future, Doyle concludes. 

“One of the challenges is when somebody first joins a company, and [if] they opt out right off the bat because they’re starting a new job and then they never get re-enrolled again, they [may] never go back and look,” he says. “By bringing them back in every year, you’re giving [plan participants] the opportunity, and they can opt out—there’s nothing to stop them from opting out every year.”