In fact, while earlier research found that automatic enrollment increases 401(k) plan participation rates (see AUTO-PILOT – Automatic Enrollment Not Enough to Overcome Inertia ), those automatically enrolled participants tend to remain at the company’s default elections – typically contribution rates of just 2-3% and in conservative, low-risk and low-return investment funds, such as money market or stable value funds.
The Hewitt study suggests that some participants, who might otherwise have actively participated, instead just roll along with the default options, Lori Lucas, defined contribution consultant at Hewitt told PLANSPONSOR.com that “…it can actually work against employees over time.”
According to Lucas, “…employees tend to remain at the rate and fund into which they are defaulted for years, even though these defaults may be inappropriately conservative for their situation. For employees who would have participated even without automatic enrollment, this can offset much of the benefit of early participation.”
At one firm in the study, 76% of automatically enrolled employees with five months of tenure were contributing at the default savings rate of 3%, 100% invested in the default money market investment fund. Two years later 39% of automatically enrolled employees were still riding with those options.
That compares with just 2% of participants hired prior to automatic enrollment that were contributing at the default rate and investment choice.
At a second firm, while automatic enrollment did result in a significant increase in participation rates (92% versus 24% of employees with five months of tenure), that gap narrowed significantly over three years (98% versus 64%).
That result suggests that, over time, most employees do understand the need for saving for retirement – and when they do, seem likely to enjoy a better “quality” of participation, maximizing the employer match, and choosing more appropriate investment options, according to Lucas.
“By automatically enrolling employees who would have participated in the plan eventually, plan sponsors may get employees into the plan earlier, but at the cost of long-term savings because of persistently poor quality savings and investing behavior by automatic enrollees.”
“Plan sponsors need to take steps to see to it that participants aren’t lulled into a false sense of security just because they are automatically enrolled in the plan.’
Worse, employers may be sending the wrong signals with default elections, according to Lucas – suggesting that a lower contribution rate and less aggressive investment fund are appropriate choices. “Given the stickiness of defaults, employers may want to consider default funds and contribution rates that are more appropriate for the average participant over the longer term.”
That could include choices which employers have traditionally been reluctant to embrace – a higher minimum contribution rate that would draw the maximum employer match, and choosing a balanced, or lifestyle fund (but see Lifestyles Often Viewed As Just Another Fund, Cautions Hewitt ) that offers a more diversified return.
Historically, employers have been inclined to choose defaults that would not represent a significant financial hardship for workers – and default funds that would presumably offer an incrementally positive return, regardless of market conditions.
Take the Money And Run
The Hewitt study also found that when automatically enrolled employees leave an employer, they are more likely to take a cash distribution instead of rolling their 401(k) balance into their new employers’ plans or IRAs. This behavior appears to be directly linked to the smaller account balances accumulated by these employees.
Additionally, at all three companies studied, lower paid employees were most likely to remain at default.
The Hewitt study examined the participation and default behavior of 100,000 eligible employees hired before and after automatic enrollment was initiated at three US companies over a two-to-three-year period. The study was conducted in conjunction with faculty and researchers from Harvard University and the University of Chicago.
– Nevin Adams firstname.lastname@example.org