At an industry conference for defined contribution (DC) plan sponsors, Mark Iwry, Deputy Assistant Secretary for Retirement & Health Policy and author of the 2006 Pension Protection Act which inspired the use of auto-features like auto-enrollment, said his biggest regret was suggesting a 3% default deferral rate. Being cautious and wanting to entice more companies to use auto-enrollment, suggesting a more conservative default rate was certainly understandable. But along with out of date match formulas, a low deferral rate can hurt not only retirement savers but also the company.
There’s good news from T Rowe Price plans which saw an almost doubling of DC plans using a 6% default rate since 2011 to 29%, but smaller companies tend to be more cautious. As outlined in TPSU’s Ideal Plan, a 30 years old employee making $45,000 over a 35 year career starting at 6% escalating to 12% with a 3% match will have three times as much saved compared to saving at a stagnant 3%.
By setting a default deferral rate at 3% and not escalating it, the message to employees is that 3% is all that is needed to adequately prepare for retirement. Even in robust markets when greater returns were realized, 3% is too low – experts predict much lower market returns in the future so people need to either save more or take more risk, probably both.
Another issue is the match. Companies that match 100% of 3%, for example, might think they are being generous but what they are doing is rewarding bad behavior. Workers’ deferral rates gravitate to the match so a stretch match of 25% of the first 12%, which costs the company the same, will result in better outcomes. At a recent TPSU program, a quasi-government agency said they provide 13% to their workers’ retirement plan before employees even contribute which leads to many not saving at all. It’s worth considering whether generous companies should consider using these matches to engender good behavior for the benefit of all.
Finally, defaulting at a low deferral rate can hurt the company. Provider and advisor cost are generally based on the number of plan participants while revenue is based on assets. Low account balances mean less revenue and profit not attractive to many high end providers or resulting is very high fees to participants. It can also result in more work for HR professionals who have to use low cost do-it-yourself providers, more errors and potentially legal issues.
Attrition at 6% deferral rates is almost the same as 3% meaning workers want employers to do for them what they may not be able to do for themselves. The time for 6% deferral default rates in now.
