For DC plans, auto escalation remains an underachiever due to sponsors' opt-in strategy

Automatic enrollment encourages more defined contribution participants to put more money into their accounts. But its auto-escalation cousin remains an underachiever due to a strategy that fails to capitalize on participants’ inertia.

DC plans offer automatic enrollment, allowing participants to opt out of automatically contributing to a retirement account. Thanks to inertia, relatively few retirement plan members drop out, even as plans have increased auto-enrollment deferral rates over the years, researchers and DC consultants say.

Retirement plans offering auto escalation can use the opt-out strategy, or they can tell participants they must opt in. For the latter approach, participant usage is chronically low, according to research by T. Rowe Price of its record-kept clients that offer auto features.

For the opt-in group, participant usage was only 11% last year — an annual rate that has been consistent since 2014, never rising higher than 13% in any year.

By contrast, 61% participated in auto escalation via the opt-out approach last year. Since 2014, the annual peak usage was 67% in 2017 and again in 2018.

“That’s exactly what we have seen in the field,” said Michael J. Francis, president and co-founder of retirement plan consulting firm Francis LLC. “In reality, opt-in is rarely used.”

Francis recommends DC clients pair auto escalation with auto enrollment and use opt-out for both, adding that 95% of the firm’s clients that auto-enroll participants also feature auto escalation.

Clients who resist the opt-out strategy for auto escalation say it “feels too Big Brother,” said Francis. “They say it feels like we are pushing too hard.”

Participants should try for an annual retirement savings rate of at least 10% of pay "with the hopes that this number will grow higher with the addition of certain employer discretionary or matching contributions," he said.

His company provides clients with an annual “plan utilization review,” which compares plan participation and participant savings rates against three benchmarks: the previous year's numbers, the industry average for their company type, and "an aspirational goal," he said. His company discusses communication strategies and plan design options to improve participation.

Plans that use opt-in vs. opt-out cite several reasons for their choice, said Michael Volo, principal and financial adviser for CAPTRUST Financial Advisors.

“Some may be on antiquated payroll technology” that doesn’t work with their record keepers’ platforms, he said.

The primary reasons for sponsors avoiding the opt-out strategy "are increased employer cost and workforce fit," Volo explained. "The cost issues is related to plans that may have to provide an employer match on the increased employee contribution. If that is the case, employer costs could be substantially higher in an opt-out environment vs. the participant having to opt in because participant inertia leads to inaction."

Clients with a lower-paid workforce say an opt-out auto escalation would be “unfeasible” because they don’t want employees to feel challenged if they are already being auto-enrolled and receiving a company match, Volo said.

A majority of his clients’ plans offer the opt-out approach for auto escalation. “It’s a great solution,” he said. “It simplifies decision-making for the participant.”

For clients on the fence about the opt-out strategy, some will review the strategy in the future, perhaps offering it to so-called undersavers and/or new employees, he added.

“There is very little downside to implementing auto escalation on an opt-out basis,” he said. “We don’t hear much employee blowback.”

Whatever strategies clients use, "a rule of thumb is to aim to have a contribution rate of 15% of compensation or greater," Volo said. "This encompasses both employee and employer contribution sources."

Choosing opt-out vs. opt-in depends on the corporate culture, said Scott Boulton, principal and senior consultant at Fiducient Advisors. He detects a gradual, greater willingness among clients to offer opt-out auto escalation.

Resistance is based on employers’ belief that opt-out is “too much of an overreach” for auto escalation, he said. The drawback to opt-in is that “you are asking people to take action,” he said. “If they don’t understand it, they don’t do it.”

Boulton recommends clients establish a negative election like they do with health care, requiring annual renewal. Asking employees to confirm participation in auto enrollment and auto escalation each year using the opt-out approach should improve usage, he said.

Plans are slowly moving to greater use of the opt-out strategy in auto escalation, according to T. Rowe Price research. In 2014, the ratio of opt-in to opt-out among plans offering auto-escalation was 63%-37%. Last year it was 51%-49%.

“People are getting more comfortable,” said Rachel Weker, vice president and head of marketing retirement plan services at T. Rowe Price. “These things take time.”

When participants are defaulted into auto features, “the vast majority don’t opt out,” she said. “The data reinforces the value of opt out.”

T. Rowe Price recommends a goal of 15% annual retirement savings. To encourage greater contributions, it has created personalized videos for participants focusing on salary, contribution rate, account balance and age. “Employers can do more education and make it as easy as possible,” she said.

Auto enrollment

Weker also said more DC plans are more willing to offer higher auto-enrollment default rates.

Among plans offering auto-enrollment, T. Rowe Price data shows the once-traditional 3% default rate declined to 28% of plans last year vs. 43% in 2014. During this period, default rates of 6% or more rose to 38% of plans vs. 24% in 2014.

For auto-increase, 87% of plans had a default increase of 1% of pay last year compared to 70% in 2014, according to T. Rowe Price. Thirteen percent defaulted to 2% of pay last year compared to 30% in 2014.

Auto enrollment continues to produce a dramatic difference in participation vs. non-auto-enrollment plans. Last year, the participation rate in auto-enrolled plans was 83% vs. 36% for non-auto-enrolled plans, according to T. Rowe Price data on a participant-weighted basis. Ten years earlier, the ratio was 86% to 49%.

The percentage of T. Rowe Price-client plans using auto-enrollment was 68% last year compared to 51% in 2014.

Vanguard Group’s annual survey of its record-kept clients found similar results to those of T. Rowe Price. Among retirement plans offering the opt-in approach to auto escalation, the participation rate was 26% last year. Since 2014, the rate has ranged from 19% to 33%.

“Historically, some sponsors questioned the cost of auto-increase,” said David Stinnett, principal and head of strategic retirement consulting at Vanguard. “Some sponsors thought it was too aggressive or too paternalistic.”

Stinnett said the first goal for auto-enrollment plans is to get the initial default “sufficiently high” at 4% or more.

Vanguard clients have followed his advice. Last year, 60% defaulted 4% or more compared to 27% in 2005, according to record-keeping data. During that period defaults of 3% or less dropped to 40% from 73%.

“You want to auto-increase so it (the auto-enrollment rate) doesn’t stay there,” he said. “We tell sponsors to make sure you have both features.”

Among Vanguard DC clients, the percentage offering auto enrollment was 59% last year vs. 36% in 2014. Last year, the participation rate was 94% in auto-enrollment plans vs. 67% in voluntary enrollment plans.