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Employers are increasingly putting workers’ 401(k) plan savings on autopilot.
But new research finds the positive impact of automatic retirement savings is smaller than originally thought.
Factors that had previously been “underexamined” — such as employees cashing out their 401(k) balances upon separation — “significantly reduced” the long-term impact of policies like auto-enrollment and auto-upgrades. new paper Published by the National Bureau of Economic Research.
Importantly, some of the paper’s co-authors—Yale’s James Choi, Harvard’s David Laibson and John Beshears—are Behavioral economists who pioneered early research on the positive effects of automatic enrollment.
“They’re like the OG (originals),” said David Blanchett, director of retirement research at investment manager PGIM. “These guys have been studying this topic for decades.”
“Not as positive as we thought”
Automatic savings have been a cornerstone of 401(k) policies since Congress passed the Pension Protection Act of 2006.
Policies such as auto-enrollment and auto-upgrade are designed to increase the size of employees’ savings by automatically enrolling them in a company 401(k) and then increasing (or “upgrading”) their savings rate over time.
In this way, people’s inertia tendencies work to their advantage.
About two-thirds of 401(k) plans are using automatic enrollment as of 2022, according to survey data from the American Council of Plan Sponsors, a trade group. Of these, 78% use automatic upgrades.
Overall, their impact on savings is positive, “just not as positive as we thought based on previous research we’ve done,” Cui said in an interview.
The organization’s preliminary study did not track outcomes for workers who automatically joined the workforce.
Cui said the study update aims to conduct a broader analysis that incorporates factors such as job changes.
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Overall, Choi and his co-authors recently found that automatic enrollment increases 401(k) contribution rates by an average of 0.6 percentage points of workers’ career earnings.
The paper claims that the efficiency dropped by 72% compared with the 2.2 percentage point improvement inferred “from the results of earlier seminal papers.”
“You’re talking about a 1.6 percent reduction in income savings per year,” Choi said. “If you add up a 40-year career, you’re talking about more than half a year’s worth of income saved.”
He added that when compounding interest on those savings is taken into account, this could amount to a “considerable” financial difference.
The impact of 401(k) leaks
Much of this difference is caused by so-called “leakage” in 401(k) plans. This means withdrawing funds before retirement.
About 40% of workers quit cash their annual 401(k) plans, according to the Employee Benefit Research Institute. According to the latest data from EBRI, such leaks amounted to $92.4 billion in 2015.
Workers can withdraw 401(k) plan funds before their employer match is fully vested, meaning they give up this free money.
Additionally, the National Bureau of Economic Research paper found that only 43% of workers who had an automatic increase in their savings rate ended up accepting the higher contribution rate one year later.
By comparison, earlier research by behavioral economists such as Richard Thaler and Shlomo Benartzi estimated the rate at about 85 percent.
In addition to automatic enrollment, job flow also complicates automatic upgrades, PGIM’s Blanchett said.
For example, if a worker is joining a new employer’s 401(k) plan, his or her step-up contribution rate may reset to a lower savings rate.
Blanchette said that while automatic upgrades aren’t necessarily a surefire way to get people to save more money, automatic enrollment has proven to be “very successful.”
He argued that the effectiveness of automatic enrollment should not be judged based on 401(k) leaks, which is a separate policy issue.
“I think automatic enrollment does a great job of getting individuals into the program,” Blanchett said. “But we still have a huge leakage problem. Whether you have automatic enrollment or not, it’s still there.”
That said, there’s still room for improvement in automated savings.
“I would like our median default savings rate to be 7% or 8%,” Blanchett said.
When coupled with an employer match, the average employee can save 10 percent or more of their salary, which is something bar workers generally should strive for, he said.
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