Auto Enrollment Improves Quantity, not Quality, of Participation

May 16, 2006 ( - Hewitt Associates "2006 Hewitt Universe Benchmarks - How Well Are Employees Saving and Investing in 401(k) Plans" research report indicates that 401(k) participation rates are slowly increasing for younger, lower-tenured, and lower-salaried workers.

Automatic enrollment increases participation by changing the pressure of decision-making, Hewitt said in its report. The participation rate of low-tenure, younger, and lower-wage employees dramatically increases when workers are automatically enrolled in their 401(k) plan and must opt out if they do not want to participate. The study found that, in 2005, the average participation rate for plans with automatic enrollment was 14 percentage points higher compared to the participation of plans across the entire Hewitt Universe.

Under auto enrollment, participation was 30 percentage points higher for workers with less than one year of tenure, and participation was 21 percentage points higher for workers with less than $20,000 in annual salary. Meanwhile, for workers ages 20 – 29 participation was 22 percentage points higher under automatic enrollment.

In spite of these statistics, enrollment for younger, lower-tenured, and lower-salaried workers remained relatively low, Hewitt found. A recent study suggested the lack of participation in retirement plans and other benefits signaled a lack of commitment to the employer. (See Employee Turnover Linked to Plan Participation Rates ). In fact, Hewitt said the relatively low participation level for these employee groups could be a result of the higher number of retail employees in Hewitt’s universe for 2005, and there tends to be a high rate of turnover for this employee group.

The majority of older workers participated in their defined contribution plan in 2005, but, as in prior years the majority of eligible workers in their 20s continued to avoid participation (See Younger Workers Slow to Start Saving ). Nearly three quarters of workers in their 40s and 50s contributed to their defined contribution plan in 2005, versus just 47.5% of workers in their 20s.

Low salary workers were among those with the poorest participation levels covered in the Hewitt Universe. Only 39.1% of eligible workers with salaries less than $20,000 participated in their defined contribution plan. Just less than 61% of eligible workers earning $20,000 to $39,999 participated. Even the youngest workers (workers in their 20s) are more likely than the average employee to participate if their annual salary is $40,000 or more (See Americans: Want Us to Save More for Retirement? How about a Raise? ).

While auto enrollment is highly effective at improving participation levels, it cannot guarantee high quality of participation, Hewitt notes. About one-quarter of participants had a nominal total plan balance at the end of 2005. Younger, lower-tenured, and lower-salaried participants are most likely to contribute in a nominal way, which Hewitt attributes in part to nominal deferral percents in auto enrollment programs.

A total of 42.5% of participants age 20 to 29 contributed under 5% of pay, compared to 35.6% in 2004, the report said. Nearly 40% of participants with less than one year of tenure contribute under 5% of pay, compared to 35.4% in 2004. Almost half (49.4%) of participants earning less than $20,000 per year contributed under 5% of pay versus 40% in 2004.

Also attributable, in part, to the higher incidence last year of automatic enrollment and default contribution levels set at nominal levels, is the fact that, in 2005, 21.8% of participants did not contribute enough to their 401(k) plan to obtain the full company match. Approximately 30% of participants contributed only enough to their plan to obtain the full employer match - but an even higher percent of those participants did so in 2005 than in 2004.

Automatic enrollment may also contribute to the low percentage of certain workers to invest in equities. The average participant age 20 - 29 had about 66% in equities at the end of 2005. In contrast, participants ages 40 - 49 had 69.3% in equities at the end of last year. Younger workers are less prone to diversify away from investments such as GIC/stable value when their portfolios are defaulted into such investments under automatic enrollment, however, some surveys show that younger workers believe they lack investment knowledge and feel ill-equipped to make 401(k) decisions. This may cause them to invest too conservatively for their time horizon, Hewitt said.

One behavior the study found that lower-tenured workers engaged in properly concerned the allocation to pre-mixed portfolios. The number of participants using premixed portfolios as a turnkey solution is increasing - up from 15% in 2004 to 19.9% in 2005. Hewitt found that low-tenure participants are the most likely to have balances in premixed portfolios: 57.5% of participants with less than one year of tenure invested in premixed portfolios in 2005, and those with one to two years of tenure had almost 15% of balances in premixed portfolios. Of those low-tenure participants investing in premixed portfolios, nearly half invested all of their 401(k) monies in a single premixed portfolio.

The use of premixed portfolios that utilize auto-rebalancing would be helpful to more workers as the study finds that workers are still prone to not rebalance their assets on a periodic basis. There are many reasons why 401(k) participants do not rebalance or reallocate their portfolios on a periodic basis, Hewitt found. Participants may confuse rebalancing and reallocation with market-timing, which they have been told to avoid.

Rebalancing can also be a counterintuitive and even an emotional activity since participants may be loath to shift money from their best-performing investments into their worst-performing investments in order to rebalance. In fact, studies have shown that emotions and impulses can negatively affect an investor's retirement planning habits (See Emotions Negatively Affect Investment Decisions and Emotions and Impulses Contribute to Bad Retirement Planning Decisions ).

Other key findings of the Hewitt benchmark report include:

  • The average eligible employee is age 42, earns an annual salary of $52,120, and has approximately nine years of tenure with his or her employer.
  • In 2005, 67.2% of eligible employees participated in their defined contribution plan.
  • As in prior years, the average participant's largest holdings in 2005 were in company stock (21.9%), GIC/stable value (18.2%), and large US equities (18.2%). At the same time, participants' allocation to non - US equities increased in 2005. The average participant had 6.1% of balances in international and emerging market equity funds, up from 4.4% in 2004.
  • Company stock remains the single largest holding for participants in plans with company stock.
  • The proportion of participants with loans outstanding remains consistent year over year. In 2005, 22.4% of active participants had a loan outstanding, in line with 2004 levels. Middle-age and middle-income participants most commonly have outstanding loans. About 13% of individuals with loans outstanding did not contribute to their 401(k) plan at all in 2005.
  • In 2005, the average defined contribution plan in the Hewitt Universe offered 14 funds diversified across eight asset classes.
  • In 2005, the average participant spread his or her 401(k) investments across 3.9 asset classes.
  • In 2005, 2.2% of participants with access to a SDBA had balances in a SDBA. This is consistent with utilization levels of prior years. Participants with high total plan balances and high salaries are most likely to use the SDBA.
  • Just over one-quarter (27.1%) of participants changed their contribution rate in 2005.
  • In 2005, 90.2% of all transactions were performed via the Internet, a 2.3% increase from 2004. Only 2.7% of all transactions were performed through the Interactive Voice Response system, a decrease of 4.8% in 2004. The usage of the Benefits Center for transactions was unchanged from last year.

Hewitt's analysis examines the saving and investment behavior of more than 2.6 million eligible employees and more than 1.7 million active participants based on empirical data across over 130 large defined contribution plans, with an average of 20,000 eligible employees in each plan.

align="left">Copies of the complete report are available for $350 by contacting the Hewitt Information Desk at (847) 771-2500 or .