Retirement Ball’s in Employers’ Court

If employers want to improve the poor retirement prognosis for a large chunk of American workers, there are some obvious things they could do.

That’s the big takeaway in Morningstar Inc.’s new report on employers that offer 401(k) plans to their employees but don’t do what’s required to encourage them to save enough.

During the early 2000s, automatic enrollment to increase participation in employer 401(k)s became all the rage, and the strategy has proved itself. Today, nearly 90 percent of automatically enrolled employees stay where they are put, while only about half of workers sign up to save when 401(k) enrollment is strictly voluntary.

But the auto-enrollment trend has stalled, and the crazy-quilt, private-sector retirement system still has a lot of holes in it.  Even when companies automatically enroll their workers, the plans are often designed in ways that discourage them from saving enough, Morningstar’s David Blanchett, head of retirement research, concludes in his report.

“Too often the focus among plan sponsors is improving [401(k)] participation,” he writes. The plans themselves have left us “with low and inadequate savings rates that threaten the retirement security of many Americans.”

At least there’s something to be improved upon: many private-sector employers don’t even offer retirement plans, particularly in industries when people earn low-incomes or work for small companies.

Blanchett’s critique of plans already in place rightly leans on groundbreaking academic research a decade ago that tested 401(k) plan design to determine what drives employee participation and how much they’ll agree to save.

Take plans with auto-enrollment. His analysis of T. Rowe Price and Vanguard client data found that     3 percent of salary remains the most popular savings rate that employers default their workers into during automatic enrollment in the plan – but 3 percent is widely viewed as inadequate if a worker wants to have enough money to retire on.

Why so low, Blanchett asks, when people might accept more?

For example, those who sign up voluntarily for 401(k)s tend to select higher savings rates than those who are automatically enrolled.  Further, the acceptance rate in the auto-enrollment plans he analyzed was roughly the same whether the defaulted rate was 3 percent or 6 percent.  He suggests a higher default rate in auto-enrollment plans (10 percent?) would better prepare employees for retirement – and they might even accept it.

Employees might also be encouraged to save more if their savings rates increase over time. Here’s how it works: an employee enters a plan, contributing perhaps 3 percent of his salary to the company 401(k). This low percent gradually increases over time, perhaps as he receives raises at work.

While many employers have adopted escalating contributions, it’s usually optional and not automatic. And guess what? Employees, asked to choose this feature, usually don’t – just as they resisted saving in their 401(k)s before auto-enrollment was introduced. Why not make escalation automatic and let workers opt out if they don’t like the idea?

One possible reason for low savings rates is that it costs employers money to match their workers’ contributions. One obvious solution Blanchett put forward is that employers matching 100 percent of the employee’s first 3 percent of savings instead match 50 percent of the employee’s first 6 percent. This would have to be tested to see if it’s an effective strategy.  But if it worked, it would increase how much employees save for themselves, without costing the employer more.

The academic research has taught us a lot. At the heart of Blanchett’s analysis is the question: why aren’t employers using the insights more effectively?

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