Plan Design Impacts Participation Rate

September 29, 2004 ( - 401(k) plan sponsors interested in beefing up their participation rate should seriously consider automatically enrolling employees, a new study asserted.

Research by two Harvard University economics professors and a professor at the University of Pennsylvania’s Wharton School claimed that an automatic enrollment program represents a plan sponsor’s “single most effective (participation rate) intervention.” The researchers studied the experiences of three unnamed companies.

To get around the two downsides to automatic enrollment – potential legal liability and participant inertia that most often prompts participants to stick with the default options chosen by the employer – plan sponsors can revert to what the researchers label the “active decision” approach. That requires employees to affirmatively decide on whether to join the plan by a specific deadline.

“(Under active decision) Employees do not face an employer-selected default contribution rate and asset allocation and consequently end up choosing for themselves,” researchers James Choi, David Laibson and Brigitte Madrian wrote.

The active decision approach has worked well for some plan sponsors, the researchers reported. Three months after hire, K plan participation is 28% higher for those required to indicate their join or not join decision compared to those at firms with more traditional enrollment practices. With automatic enrollment, participation jumps to between 86% and 96% once it kicks in, the study said. After short periods of tenure, the study says, the difference between standard enrollment and automatic enrollment was more than 50% at six months of tenure.

Plan eligibility policies also affect participation to a certain degree. According to the study, the gap between the higher participation at companies with immediate eligibility and those at firms with a waiting period closes without a few months after the waiting period expires. Whether the firm has an employer match also comes into play with a match tending to lead to earlier K plan participation. A 25% match leads to a roughly 40% hike in tenure-specific participation rates, the researchers said. Offering loans and limiting the number of fund choices can also bump up participation, but not as markedly. “The participation effects from these interventions are decidedly smaller than those that can be obtained by focusing directly on facilitating enrollment,” the researchers wrote.

The study said most firms choosing automatic enrollment have also chosen a conservative default investment option – typically a money market or stable value fund. Not surprisingly, automatic enrollment in those environments produces a more conservative portfolio.

“The central finding that plan design matters in economically significant ways places a tremendous responsibility on both employers and government regulators,” the study concluded. “Whatever plan design an employer chooses will favor certain outcomes over others. Employers can try to escape making tough decisions about how and how much employees ought to be saving for retirement by giving employees choices and letting them decide for themselves. However, even this type of laissez-faire plan design will itself influence outcomes relative to other design choices that could have been made.”