There’s been a lot of discussion recently about whether the automatic enrollment feature in many 401(k) plans actually leads to lower overall retirement savings rates. This blog post gives a brief overview of the issue and proposes a couple of solutions to combat automatic enrollment inertia and enhance employee engagement in the retirement plan.
Background: Automatic enrollment is an optional 401(k) plan feature which allows employers to defer employee compensation into their 401(k) accounts, even if they haven’t elected to do so (they can always opt out). A recent article explained how 401(k) automatic enrollment may have unintended consequences.
Automatic enrollment can overcome employees’ initial inertia to saving more than 0% in the 401(k) plan (Participation Inertia), but it could unintentionally cause some employees to get stuck at the default rate (Default Inertia) instead of saving more.
If we can agree that automatic enrollment is a good idea because it helps overcome Participation Inertia, then we just need to devise a solution to the Default Inertia problem.
Solution #1: Add auto-escalation to the automatic enrollment option. As mentioned in the WSJ article, this feature automatically increases the default deferral rate each year that an employee participates in the plan. For example, the automatic deferral rate might be 3% for new employees with 1% annual increases up to an ultimate deferral rate of 6% of pay after 3 years.
However, even automatic escalation will eventually leave most participants at the ultimate default rate. And many of them will need to save more than this ultimate rate in order to have any chance of accumulating sufficient retirement assets.
How can an employer help “remind” these employees of their ability to save at higher levels without becoming a financial adviser? By doing their best to continuously engage employees in their retirement plan with Solution #2.
Solution #2: Hosting an annual retirement plan education session for all employees. This relatively short presentation would include:
- Explanation of how the employer-sponsored retirement plan works. Many employees may not understand the plan or the fact that they could be getting an employer match.
- Demonstration of how to change deferral and investment elections.
- Overview of investment options in the 401(k) plan and where employees can get more information
- Reminder that the auto enrollment deferral rate is a default rate, and that employees may need to save more to meet their retirement goals.
Many of these topics are probably already provided to employees online or covered in a pamphlet given to them on their first day of work. However, those are passive education methods. The retirement plan education session sends a stronger message by actively educating employees. It has the ability to:
- Overcome the passive inertia that employees may have to gathering the information themselves.
- Build employee engagement in the retirement plan and increase their appreciation for this benefit.
- Reinforce the importance of saving for retirement and directly address Default Inertia.
If your company’s 401(k) plan has low employee participation rates or if participants are stuck at default deferral rates, then the plan is not living up to its full potential. An annual employee retirement education session can help solve these problems by actively promoting better participant understanding and appreciation of their employer-sponsored retirement plan.
