Default deferral rates for DC plans get a nudge up

Defined contribution plans that offer auto enrollment are moving away from the traditional initial deferral of 3% of annual salary to higher amounts — sometimes to 6% or more — nudging participants to expand their contributions.

The efforts are a welcome sign to executives in the retirement industry who have been encouraging higher contributions so participants can move closer to recommended savings rates and take full advantage of corporate matches.

“This is a great trend,” said Jean Young, senior research analyst at Vanguard Group Inc.'s Center for Investor Research. “This is a real positive evolution.”

Among Vanguard clients offering auto enrollment, 44% had a 3% initial deferral last year - down from 60% in 2008. During the same period, plans offering 4%, 5%, 6% or higher initial deferral rates rose to an aggregate of 48% of auto-enrollment clients vs. 25%. (Also, 15% of plans had deferral rates below 3% in 2008 vs. 8% last year)

Early adopters of auto enrollment might have started at 3%, but they have raised the deferral rates thanks to “stronger, smarter plan design,” Ms. Young said. New adopters of auto enrollment, she added, “have taken advantage of research” that dispels oft-cited concerns about auto enrollment — namely that lower-wage workers can't afford to save and that opt-out rates would soar if plans moved beyond the 3% initial deferral level.

One Vanguard client that raised its deferral rate is Subaru of Indiana Automotive Inc., Lafayette. It offered a 3% rate in 2006, then raised the rate to 6% on Jan. 1, 2016, for new employees.

The company wanted more people to take advantage of the corporate match — 50 cents for each dollar of salary up to 6% of pay — and encourage people to save more, said Melissa Hubler, manager of associate benefits for the company's 401(k) plan, which has $511 million in assets and covers 4,885 participants.

“We hope they will contribute beyond the 6%,” said Ms. Hubler, adding her company recommends participants save 15% to 18% of their pay annually for adequate retirement savings.

Because the company also makes a discretionary payment to employees of 5% to 7% each year — it was 7% in 2016 — Ms. Hubler said this contribution plus the corporate match and the higher deferral put participants well on their way to achieving the annual goals recommended by the company. “We want to make sure they take advantage of the total compensation package,” she said.

Subaru of Indiana also uses auto escalation for employees identified as “undersavers,” those contributing less than 6% of their annual pay to their retirement accounts. The auto escalation is 1%-per-year of salary, although participants can request up to 3%. The auto-escalation policy took effect in July 2016. Employees can opt out.

Ms. Hubler said some managers were worried that employees might push back or opt out if the deferral rate grew to 6% from 3%. “There was no noise at all,” she said.

Research by Wells Fargo Institutional Trust & Retirement confirms that opt-out rates for a 3% deferral rate are almost identical to those rates at 6%, said Melissa Hooker, the Charlotte, N.C.-based senior vice president and head of relationship management.

For the former, the opt-out rate was 11.3%; for the latter, 11.4%. “That helps clients understand” they can raise the deferral rate without much objection from participants, she said.

The research also found that lower-income and higher-income participants have “virtually the same” opt-out rates, said Ms. Hooker. “Our job is to do some myth-busting.”

Clients must weigh the fears of employees' negative reactions against participants lacking enough money to achieve an 80% income-replacement ratio in retirement, she said. That 80% represents a combination of retirement plan savings, Social Security and participants' non-retirement savings.

Wells Fargo executives recommend plans using auto features encourage participants to save at least 10% of salary a year — starting with a 6% auto-enrollment deferral and employing a 2% of pay a year automatic escalation. “You need the two elements of plan design working together,” she said. “If you stay at 3%, you will not have enough.”

Although service providers say large plans are more inclined to offer auto features and higher auto-enrollment deferral rates, one Wells Fargo client, Riddle's Group Inc., Rapid City, S.D., showed a small plan can make a big effort to encourage greater savings.

The company's $20 million 401(k) plan started auto enrollment with a 1% deferral in 2013.

“We realized at the time that this was just start,” explained David Westergaard, executive vice president, CFO and treasurer of the jewelry-store chain. The plan raised the rate to 3% in 2014 and 6% in 2016.

The deferral rate was raised to 6% so employees can take better advantage of the company match — 50 cents on each dollar up to 6% of pay. The plan added auto escalation in 2014 at a rate of 1% of salary a year, with a cap of 10%. “Very few people opt out,” Mr. Westergaard said of the plan, which has 700 participants.

Like executives of many other DC plans, he said Riddle's executives debated whether the higher deferrals might be viewed by employees as creating a Big Brother atmosphere and/or pushing employees to opt out. “There was no difference” among opt-out rates at the 1%, 3% or 6% deferral levels, he said. Each opt-out rate was less than 1%.

Auto enrollment is for new employees as well as for those who are contributing less than 6% of pay per year. The auto enrollment takes effect at the beginning of each year, and employees may opt out. The company sends three separate mailings to employees alerting them to the auto-enrollment policy.

Maximizing participants' use of the company match was the main reason another Wells Fargo client, Southern Illinois Healthcare, Carbondale, raised its auto-enrollment deferral rate in 2013 to 5% from 3% for new employees, said Julie Neubig, benefits supervisor of the $197.5 million 401(k) plan that serves 3,933 participants. The match is 50 cents for each dollar of annual salary up to 5% of pay.

“This was a good-will effort to make sure people were prepared for retirement,” said Ms. Neubig. In addition to the match and the annual deferral, the plan offers auto escalation — 1% of pay per year — with a cap of 10%. Employees can opt out of both auto features.

“We try to get them to do at least 10%” of annual pay, said Ms. Neubig, adding this amount plus Social Security and outside income will help participants achieve an 80% retirement replacement income goal.

The upward trend in auto-enrollment deferral rates is heavily motivated by companies encouraging greater use of corporate matches, said Meghan Murphy, director of thought leadership at Fidelity Investments, Boston. “Six percent seems to be the anchor point to enable people to meet the match,” she said. “The employer match is highly valued.”

Selected data provided by Fidelity shows 62% of the firm's record-keeping clients offering auto enrollment had a 3% deferral rate for the quarter ended March 31, 2007. By March 31, 2017, Fidelity said 48% of plans were at the 3% level.

During that same period, plans offering a 6% deferral rose to 18% from 6%, and the percentage of plans offering a 4% initial deferral rose to 12% from 9%.

For Fidelity, a desirable annual savings rate for participants would be 15%, which could be achieved through auto features plus corporate matches and/or other corporate contributions as well as voluntary contributions, Ms. Murphy said.