Auto-pilot: Creating a New Behavior with Plan Design

We all have heard it: “There is a retirement savings crisis in our nation.” Front pages of newspapers and magazine headlines, television specials and radio programs, academic journals and congressional reports have been sending stern warnings about poor savings levels for a number of years. Recently, the Employee Benefit Research Institute reported a double-digit increase in the numbers of workers who are “not at all confident” that they will have enough money in retirement, from 10 percent in 2007 to 28 percent in 2013. Why is it that we still have such a challenge saving for retirement? Is there a light of hope looming on the horizon?

In the early 1900s average life expectancy in the Unites States was about 47 years; today, that number is 78. Life expectancy nearly doubled in the 20th century, expanding at the growth rate of all the preceding millennia combined! Dr. Laura Carstensen, director of the Stanford Center on Longevity, says that whether we immediately recognize it or not, the continuing leap in longevity is reshaping every aspect of our lives, from familial relationships to educational and career pursuits to investing and saving.

The Opt-Out Approach Could Be the Answer

Our current retirement system is largely built on the premise of awareness, responsibility, understanding, and careful, thoughtful planning. At least that’s what the opt-in retirement programs prevalent today presuppose: a participant will make an affirmative election to set aside some of his or her current income to accumulate a nest egg sufficient enough to provide for his or her golden years. What’s more, the nest egg needs to successfully withstand the ups and downs of markets; a tall order indeed. Opt-in programs are seldom effective, but the opt-out approach has much better results. For example, there are far more organ donations in countries with opt-out organ donation policies than in those where the opt-in policy is the norm.

How do we do it?

A number of retirement plan design tools are built on the opt-out premise and have already made a significant impact on savings rates. A recent New York Times article points out that, according to estimates of the behavioral economists Shlomo Benartzi and Richard Thaler, more than four million people use a form of automatic savingsescalation and have already collectively increased annual savings in the Unites States by $7 billion per year.

If the number-one factor in determining how much you’ll have at retirement is the amount you save, closely followed by a well-thought-out asset allocation, we have to pay close attention to three plan features:  auto-enrollment, auto-escalation, and auto-default.

Auto-enrollment allows plan sponsors to automatically bring eligible employees into the plan at an initial salary deferral rate specified in the plan. Employees are given an opportunity to completely opt-out of the plan or modify their savings rate to a lower or higher number. The initial rate varies depending on sponsor objectives, plan design, and certain regulatory guidelines. Typically, it starts at 3 percent of compensation, although in recent years many plans increased that threshold to 6 percent. Auto-enrollment can be structured in many ways; it can be offered exclusively to new employees, it may engage those who do not defer despite being eligible, include those saving below the initial deferral rate used for auto-enrollment, or any combination thereof.

Auto-Enrollment Benefits Employers, initially skeptical of employee interest and program adoption, are typically surprised to discover later that this feature is in fact very popular with employees as evidenced by the take-up rates of 70 to 85 percent. Other than increasing savings, auto-enrollment brings a number of other benefits, which include:

  • Improvement in 401(k) testing results, which translates into the ability of the highly compensated employees to save more for retirement,
  • Ability to transition from a fully vested Safe Harbor contribution to a discretionary contribution subject to a vesting schedule,
  • A way to address top-heavy dilemmas, and
  • A boost to employee recruiting, morale and retention.

A study by Harris Interactive on behalf of Retirement Made Simpler found that 85 percent of workers said that automatic enrollment helped them to start saving earlier than they would have otherwise. Coupled with auto-escalation, this feature becomes a powerful tool in generating higher account balances and better retirement outcomes.

Auto-escalation: Auto-escalation may be combined with auto-enrollment or used on its own. When implemented, this feature automatically adjusts participants’ deferrals at a rate described in the plan document, typically 1 percent, up to a certain threshold also spelled out in the plan, often 10 percent. Similar to auto-enrollment, certain plan design parameters laid out in regulations may dictate the rate increase and its ceiling. Combined with auto-enrollment, auto-escalation can boost participation of employees typically disengaged from the plan for a variety of reasons and also, may help improve non-discrimination testing results. When offering a matching contribution, the employer can manage the cost of matching with deferral rate increases by raising match thresholds; for example, changing a match of 50 percent up to 4 percent of pay, to 25 percent up to 8 percent of pay. The cost of matching does not change for the employer: it stays at 2 percent of total payroll, but its design helps support deferral rate increases.

But will the increases stick?

A survey conducted by State Street Global Advisors in 2012 revealed that plan participants across all age groups have a higher “pain threshold” when it comes to their savings than their employers might expect, even when facing recession and other demands on their budgets. Moreover, participants welcome that type of intervention. When offered an automatic contribution increase of 1 percent per year, 52 percent of participants indicated that they would go to the expert-recommended savings rate of 10 percent or beyond, and only 12 percent would opt out of the plan entirely.

Auto-default: The Department of Labor (DOL) provides plan sponsors a special exemption, a safe harbor, for investing contributions of participants who did not make an investment election. When those participants are placed, or defaulted, in certain types of investments called qualified default investment alternatives (QDIA), plan fiduciaries are able to reduce their liability exposure. There are three kinds of QDIAs designated by the DOL: target date funds, lifestyle funds, and managed accounts. Auto-enrolled participants are typically invested in a target date based on their age; they are also given an opportunity to reallocate their contributions using investment options available in the plan.

By placing auto-enrolled participants in a professionally managed solution, plan fiduciaries may also help participants improve their investment experiences and outcomes. A 2013 survey conducted by MFS revealed amajor disconnect between participant allocations, their understanding of risk, risk profiles across different asset classes, and their expectations.

Re-enrollment: There is a new trend among plan sponsors who have adopted a practice of re-enrolling all plan participants, or restarting the plan from an investment perspective. The plan provides a notice to all participants requiring them to redirect their investments by a specified date; the same notice contains a description of plan investments including QDIA. Participants are asked to (1) elect to make no changes, (2) alter the mix, or (3) do nothing. After the deadline passes, those participants who did nothing are defaulted into a QDIA. This approach helps to ether actively engage plan participants in revisiting their investment allocation or place them into an appropriate professionally managed solution, while improving participant investment experience and protecting plan fiduciaries.

How We Can Help

Unfortunately, many employees find it hard to enroll for a variety of reasons, even when they’re aware of a retirement plan. Automation can greatly increase participation rates, savings balances, and improve investment outcomes. And while participants look to employers for guidance, employers in turn seek assistance from financial advisors.

First Allied Retirement Services offers review and strategic redesign of qualified plans from the old opt‐in to an opt‐out approach, which capitalizes on what is so common to human beings—indecision and inertia—by offering auto‐enrollment, auto‐escalation, and utilization of qualified default investment alternatives. Call us at (888) 926-0600 or send a message to We are happy to work with you and your current or prospective clients to assess benefits of incorporating auto-features in their retirement programs.

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