401k Savings Rates Insufficient to Retire
401k savings rates today are not sufficient for most people to retire. 401(k) plan design has markedly improved over the past decade-plus; however, 401k savings rates are too low for American workers to comfortably retire. 401kTV has previously written about plan design and its correlation to participation and savings rates (here and here). However, despite best efforts to “build a better mousetrap” when it comes to 401k plan design, it seems employees still aren’t saving sufficient amounts in their workplace retirement plans.
More than 50% of retirement plans now automatically enroll employees, and approximately a third of those use auto escalation to increase employees’ contributions each year, according to InvestmentNews. Nonetheless, despite these innovations in plan design, 401k plan savings rates do not seem to be where they need to be to have participants ready for retirement.
According to Vanguard’s 2019 “How America Saves” report, retirement plan participants’ 401k savings rates have remained relatively flat over the past 15 years. The average savings rate in 2018 — including employee and employer contributions — was 10.6%, according to the Vanguard report. That is only slightly higher than in 2004, when participants saved 10.4% of their pay. Vanguard aggregates data from the plans for which it provides recordkeeping services to compile its annual report on the state of retirement savings in America.
Have auto features and 401k plan design innovations failed? Well, not entirely, though some experts believe that a 10.6% savings rate is rather low given the purported success of auto features in retirement plans in boosting retirement plan savings and participation overall. To be sure, the 10.6% overall savings rate falls quite short of the guidance from financial planners and the retirement industry that workers should save 15% of their salary for retirement. However, it’s “not too shabby,” according to Wade Pfau, professors of retirement income at the American College of Financial Services, who was quoted in the InvestmentNews article. For workers who get started in their 20s, a 10.6% savings rate “should be more than adequate,” Professor Pfau noted.
InvestmentNews asked the all-important question, however: “… why isn’t the rate higher, given improvements in 401k plan design?”
Part of the issue with 401k plan design success — or lack thereof — lies in implementation. While more than 50% of plans have adopted auto enrollment as a best practice since the Pension Protection Act was passed in 2006, around 40% of plans still don’t use it, according to InvestmentNews. In addition, not all plans implement auto-enrollment effectively.
A recurring concern is that plan sponsors auto-enrolling participants at a default deferral rate that’s far too low for them to reach their retirement goals. More than half of 401k plans enroll workers at an initial default contribute to a rate of 4% or less. The common standard auto deferral rate is 3%, according to the Plan Sponsor Council of America data cited by InvestmentNews. Add to that an employer match of 3%, and the employees who were auto-enrolled in those plans are only saving an average of 6%, depending on the formula for the employer match. Moreover, the majority of plans (53%) only offer auto-enrollment for new hires, which means existing employees don’t reap the benefits.
In addition, some plan sponsors are reluctant to implement auto escalation for fear of upsetting employees and/or causing them to opt out of the plan voluntarily. According to the PSCA data, nearly three-quarters of plans with auto-enrollment also use auto escalation to increase participant contributions on an annual basis. However, 73% of those only raise 401k savings rate contributions by 1% a year.
Increasingly, mobile and the transient nature of the workforce present additional challenges for employers when it comes to automatically increase retirement plan contributions. According to a separate Vanguard report published in 2018, also cited in InvestmentNews, half of the employees who were auto-enrolled into a plan with an automatic annual contribution increase had left the company after three years. That churn can serve to continually reset those employees’ savings rates back to the default as they start jobs at new companies, thus re-starting the auto-escalation cycle noted InvestmentNews. As plan designs continue to morph and improve and default savings rates rise, employees’ overall savings rates should continue to trend upward over time, according to Jean Young, the lead author of the Vanguard “How America Saves” report.
Plan sponsors should review their current 401k plan design features and determine if there are areas for improvement when it comes to automatic default deferral rates and contribution increases. Then, make the necessary adjustments to 401k savings rates to help participants in reaching their actual retirement goals.
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