Deferral rate a recession victim

Defined contribution plan participants are cutting their contributions as day-to-day cash needs take center stage for more people.

Plan executives and industry experts say employee deferral rates are showing signs of decline.

According to data from Hewitt Associates, Lincolnshire, Ill., overall DC deferral savings rates dropped to 7.4% of salary as of Dec. 31, from 7.8% a year earlier.

Also, 5% of employees terminated their 401(k) plan contributions entirely last year, compared to 3% in 2007.

The average pre-tax contributions based on age, salary and tenure were all down in 2008 as well.

“Employee nervousness is considerable out there, and employers are overwhelmed in this environment,” said Pamela Hess, defined contribution practice leader at Hewitt. “By the end of 2009, we can see employees making further reductions in their contribution rates as everyday pressure to make ends meet increases and nervousness rises. This will slowly increase pressure to lower their contribution rates.”

David Wray, president of the Profit Sharing/401(k) Council of America, Chicago, agreed, but added he believes the contribution decreases are coming from participants at the higher end of deferral rates and in excess of the level where a employer's matching contribution stops.

“Perhaps people who save 9% or 10%, beyond the match limits, are driving this overall movement to lower contribution rates,” Mr. Wray said.

When asked about how to halt sliding deferral rates or stop workers from opting out of retirement plans, Ms. Hess said: “The reality is some people might not be able to contribute to their 401(k) retirement plan (this year).”

She added: “It might take a year to get employees back in the plan via automatic re-enrollment processes.”

Ms. Hess warned that if the economy continues to decline, deferral rates could decline further while opt-out rates would increase.

“At what point does this deluge of bad news hit a larger and more significant portion of the working population? That's the $25,000 question,” she said.

According to data from The Vanguard Center for Retirement Research, a unit of Vanguard Group Inc., Malvern, Pa., 3.1% of active defined contribution participants in plans serviced by the money manager halted their contributions in 2008. That compares to 2.4% in 2007.

Two-thirds of all participants who stopped contributing in 2008 did so in November and December, when 1.1% and 0.95%, respectively, halted contributions.

November's level might be the result of “exceptional market volatility,” according to Vanguard. Steve Utkus, head of Vanguard's Center for Retirement Research, said he expects the rate of employees opting out of DC plans to rise to 4% if the economic downturn continues or lingers.

“What we're seeing is 70% to 80% of employee deferral rates are not changing, but changes are happening at the tails” of a bell curve, Mr. Utkus said. “This might be a harbinger of things to come, not a large scale trend, but more a micro trend.”

Mr. Utkus said current data show that the median worker has not reduced his deferral rate. “We're trying to figure out who exactly is dropping deferral rates, and also who is increasing it,” he said.

PSCA's Mr. Wray said while there is some decrease in deferral rates, most participants haven't lowered their contributions. He cited automatic deferral escalation and automatic enrollment programs as the likely reasons.

“We're still following the 2000-2002 pattern of savings: erosion around the edges in terms of savings rate reductions, where people need the cash,” said Mr. Wray. “But the majority of 401(k) participants are staying the course for now.”

Jaime Erickson, manager of the $1.2 billion 401(k) plan at Chicago-based AkzoNobel, said AkzoNobel plan participants are lowering their contributions, but she didn't have any statistics, but did say deferral rate reductions have been small, but overall are up vs. this time last year.

“The drop in employee deferral rates is happening, starting at the margins,” said Ms. Erickson. “A small percentage is doing it (lowering deferral rates) as a result of worries about the economy.”

Courtney Turney, benefits analyst at St. Louis-based Arch Coal Inc., said her employee deferral rates have slipped to 7% of pay as of Dec. 31 from 7.9% on Sept. 30.

“It's not a trend, but something we are seeing,” Ms. Turney said. Arch Coal's 401(k) plan has $220 million in assets.

Ms. Erickson is waiting to see how these trends will continue after AkzoNobel begins an automatic escalation program on April 1. The program will automatically increase employee contribution rates by one percentage point per year for employees who currently contribute between 1% and 5% of their salary to the company's 401(k) plan, with a 6% maximum salary deferral cap.

Lori Lucas, defined contribution leader at investment consultant Callan Associates Inc., San Francisco, noted a survey the firm conducted at the end of 2008 showed workers in November and December were lowering their deferral amount.

“Anecdotally, we are hearing plan sponsors are either beginning to face this or will face it soon, based on our conversations,” said Ms. Lucas.

Most participants tie their contribution to the employer match, Ms. Lucas said, so as more companies suspend their matches, more employees might reduce their deferrals further.

Also, Ms. Lucas said deferral decreases are compounded in locations that are being hit harder by the recession or the housing crisis, such as Michigan, home of the Big Three U.S. automakers, and Florida and Nevada, where collapsing housing prices have decimated personal wealth.