Higher Starting Deferral Rate Improves Savings Success

September 25, 2012 (PLANSPONSOR.com) Setting a higher starting point for retirement plan contributions would make a significant difference in improving workers’ likelihood of a financially viable retirement, according to new research.

Using its proprietary Retirement Security Projection Model (RSPM), the Employee Benefit Research Institute (EBRI) evaluated the impact of raising the default contribution rate for younger workers (with 31 to 40 years of simulated 401(k) eligibility) to see how many would be likely to achieve a total income real replacement rate of 80% at retirement—within the typical range of replacement rates suggested by many financial consultants. Under the EBRI modeling, more than one-quarter (25.6%) of those in the lowest-income quartile who had previously not been modeled to have a financially successful retirement (with the actual default contribution rates) would be successful as a result of the increase in the starting deferral rate from 3% to 6% of compensation.   

Even workers in the highest-income quartile would benefit; more than 18% who would not be successful with the actual default contribution rate would be successful due to the higher 6% default rate.  

Most private-sector employers that automatically enroll their plan participants do so at a default rate of 3% of pay, a level consistent with the starting rate set out in the Pension Protection Act of 2006, but a rate that many financial experts say is far too low to generate sufficient assets for a comfortable retirement. The study shows that raising the default saving rate to 6% would significantly increase the chances for achieving retirement adequacy “success” for both low- and high-income workers. 

EBRI noted that a key variable in considering the impact of automatic enrollment in retirement plans with automatic escalation of contributions is whether workers who change jobs continue to save at their previous (and typically higher) contribution rate, or whether they “start over” in the new job at the typical lower automatic deferral rate of 3%.  

Full results are published in the September EBRI Notes, “Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation,” available online at http://www.ebri.org.