Data Show That Automatic Enrollment in 401(k) Plans Has Led to Higher Match Rates from Large Plan Sponsors

New research from the nonpartisan Employee Benefit Research Institute (EBRI) finds that employers adopting automatic enrollment in their 401(k) plans have also generally increased the “employer match” to participant’s accounts—in some cases, by a significant amount.

The EBRI research is the first using actual plan information on both actual auto enrollment and actual match rate information both before and after adoption of auto enrollment. The new EBRI analysis uses plan-specific data for large employers from Hewitt Associates, and finds that employers instituted more generous contribution rates after adopting automatic enrollment, and did so when measured by several different standards.

This release provides preliminary results from the research. Full results of the simulated impact of the changes on worker’s retirement wealth will be available next month in the February 2010 EBRI Issue Brief, and will be posted online at www.ebri.org

“Our recent analysis of plan-specific data shows that, at least among large 401(k) plans, plan sponsors actually increased the generosity of their contribution rates,” said Jack VanDerhei, EBRI research director and author of the analysis. He noted that EBRI has published three separate simulation studies since 2005 showing the potential importance of automatic enrollment for future retirement account accumulation, even under the assumption that employer contribution rates would not change when the 401(k) plan was modified.

“The modifications to 401(k) plans made by sponsors in response to the Pension Protection Act of 2006 will be very important for retirement income adequacy in this country. Adding these more realistic assumptions to our simulation model will allow us to more accurately demonstrate the relative improvements in retirement accounts, especially for young and low-income workers,” he added.

The EBRI results contradict an earlier publication of the Center for Retirement Research (CRR) at Boston College and by the Urban Institute, which concluded that among a sample of large 401(k) plans, match rates are lower among firms with automatic enrollment than among those without automatic enrollment after controlling for firm characteristics.

However, there were two major limitations with the CRR/Urban published analysis:

• The study was based on U.S. Department of Labor Form 5500 data that does not include specific information on 401(k) match rates. Instead, the authors constructed an estimate for the match rate as the ratio of employer-to-employee contributions for each 401(k) plan.

• They merged the Form 5500 data with information on automatic enrollment from the Pensions &Investments database of the top 1,000 pension funds, which includes a flag indicating whether plan administrators reported offering automatic enrollment in their defined contribution (401(k)-type) plans.

However, this database does not report the year that the automatic enrollment provision was adopted, so there is no way to tell from this data source how long auto-enrollment had been implemented in a planThe authors of the CRR/Urban published study present a regression analysis on this database and produced a finding that: suggests a negative relationship between automatic enrollment and match rates and is statistically significant at the firm-level. In particular, match rates are about 7 percentage points lower among firms with automatic enrollment than among those without automatic enrollment, after controlling for firm characteristics.

While the authors correctly point out that although the regressions suggest a relationship between automatic enrollment and match rates, they do not necessarily imply that auto enrollment causes lower match rates; however, this crucial qualification has been generally ignored in recent press accounts of the study.

Earlier EBRI Research

The CRR/Urban published study conflicts with previous EBRI research published in 2007,2 which surveyed Mercer Human Resource Consulting defined benefit sponsors to gauge their recent activity and planned modifications to their defined benefit (pension) and defined contribution (401(k)-type) plans. The EBRI survey also was able to determine what, if any, increases in employer contributions to defined contribution plans were provided in conjunction with reductions to their defined benefit plans.

Although the association between the adoption of automatic enrollment and employer contributions to 401(k) plans was not the focus of the EBRI study, one-third of the defined benefit sponsors surveyed indicated that they had already increased or planned to increase their employer match to a defined contribution plan, and 20.9 percent indicated that that they had already increased or planned to increase their nonmatching employer contributions to a defined contribution plan. There was some overlap between the two groups, but overall, 42.5 percent of the defined benefit sponsors surveyed indicated that they had already increased or planned to increase their employer match and/or nonmatching employer contribution to a defined contribution plan. This was particularly true of defined benefit sponsors that had either closed a defined benefit plan to new hires or frozen the plan to all members in the last two years or planned to do so in the next two years.

Moreover, the 2007 EBRI study found an extremely large correlation between the adoption of automatic enrollment for a 401(k) plan and the freezing or closing of the defined benefit plan.4 Of those defined benefit sponsors that had closed their defined benefit plans in the last two years, 80.5 percent had either already adopted or were currently considering adopting automatic enrollment features for their 401(k) plans. Of those defined benefit sponsors that had closed their defined benefit plans in the last two years, 76.1 percent had either already adopted or were currently considering adopting automatic enrollment features for their 401(k) plans.

EBRI’s New Research and Methodology

The new EBRI study analyzes in detail 225 large defined contribution plans6 that had adopted automatic enrollment 401(k) plans by 2009, but did not have them in 2005 (the last observation that was not influenced by PPA). The following information was coded for each plan:

• The default contribution rate for the automatic enrollment (AE) plan in 2009.

• The entire match rate contribution formulae for both years.

• All nonelective contributions paid to the defined contribution participants by the employer.

Whether plan sponsors were more or less generous after adopting AE was measured with three different metrics:

1. The average 2009 first-tier match rate was 87.78 percent, while the average 2005 first-tier match rate was 81.26 percent. The difference of 6.52 percentage points suggests that, to the extent that this sample is representative of the universe of large 401(k) sponsors, those sponsors adopting AE were more generous to the 401(k) participants when measured by this variable after automatic enrollment was implemented than they were before.

2. The average effective match rate8 for 2009 was 4.32 percent of compensation, but only 4.00 percent of compensation in 2005. The increase of 0.32 percentage points again suggests that large 401(k) sponsors adopting AE were more generous to the 401(k) participants when measured by this variable after the adoption of automatic enrollment than they were before3. The average total employer contribution rate9 for 2009 was 6.35 percent of compensation and 5.46 percent of compensation in 2005. The increase of 0.89 percentage points once more suggests that those large 401(k) sponsors adopting AE were more generous to the 401(k) participants when measured by this variable than before.

Influence of Defined Benefit Plan Activity

This information was then combined with the defined benefit information for the same sponsor in an attempt to analyze whether EBRI’s 2007 findings of the association between defined benefit freezing/closing and enhanced 401(k) contributions were corroborated. The average improvements for all three metrics were much higher for sponsors that had frozen/closed their defined benefit plans than for the overall average. For example, the change in the total employer contribution rate for all frozen plans was 1.64 percent of compensation versus 0.89 percent for the overall average. Employers that had closed their defined benefit plans to new employees had an even larger average improvement: 2.82 percent of compensation.

The defined benefit sponsors that had frozen or closed their plans were then split into those that had done so prior to adopting AE and those that had changed their defined benefit plans between 2005 and 2009. If the hypothesis that the 401(k) improvements were a result, at least partially, of a simultaneous quid pro quo for the decreased accruals in the defined benefit plan, one would expect that the earlier improvement would be smaller than those that took place approximately at the time of the conversion to AE. In fact, this is exactly what is found for all six comparisons. For example, the average total employer contribution improvement for firms that had frozen their plans prior to 2005 was 0.69 percent of compensation, compared with 2.45 percent for those that froze between 2005 and 2009. Similar evidence is found for those that closed their pension plans to new employees: The average improvement in total employer 401(k) contribution was only 0.56 percent of compensation for those that closed prior to 2005, but 3.34 percent for those that closed the plan between 2005 and 2009.

-Employee Benefit Research Institute

Keeping Your 401(k) on Track

Setting up a reasonable and workable investment plan for your retirement is one of the most important decisions you can make.

But once that decision is made, your work is only half done. An equally important task is to monitor your selections and the portfolio as a whole to make sure your original plan is still on track.

What does monitoring consist of?

Most 401(k) plans are composed of mutual funds, where daily scrutiny isn't necessary or even desirable. Quarterly check-ups—a review every three months or so—is more in order.

First, you should review the performance of your individual fund holdings to determine how well the professional expertise you have hired is doing. This includes examining the performance of each fund against its peers (other funds with similar objectives) and an appropriate index. For example, if you are invested in large-company stocks, a good comparison index would be the Standard & Poor's 500.

If your funds' performance figures are good relative to the benchmarks, no problem.

However, if the figures are unsatisfactory, you need to take a closer look at the fund's manager to try to determine why the performance is off. If the unsatisfactory performance is likely to be short-term—for instance, perhaps the manager's investment style is temporarily out of favor—you should hold on to the fund and give the manager a chance to improve over time. However, if the underperformance is long-term in nature—for instance, you have been monitoring the fund for a year and the poor performance relative to similar funds is persistent—you may want to sell the fund and find a better replacement.

Second, you should take a look at the quarterly and annual reports that funds send to all shareholders. These periodic reports detail the fund holdings, and they often discuss fund performance as well as any changes that fund management may be making in light of their investment outlook. These reports should be examined to make sure that the fund continues to follow the approach that you hired it to do.

In addition to monitoring the individual components of your portfolio, you need to step back and take a look at your portfolio as a whole. Once a year, you should compare your current asset allocation with your desired asset allocation and rebalance if things are out of whack. Determining your current asset allocation is relatively easy—you simply total up your investments in any particular asset category and divide by your total investment portfolio.

If your allocation starts to stray significantly—by five percentage points or more—from your desired plan, you need to rebalance to bring your holdings back in line with your original plan.

Monitoring your portfolio of mutual funds requires only a little bit of time and a small amount of effort to ensure that your plan is on track. Ignore your portfolio—and it may just go away.

© 2010 AAII Journal

401(k) Plan Pluses and Minuses: How Does It Add Up?

Retirement is a long way down the road for many employees-an event that is barely visible on the distant financial horizon. For these individuals, retirement plans may not seem particularly important.

However, the decision over whether you should contribute to a 401(k) plan can have a big impact on your long-term financial future.

These types of retirement plans offer significant advantages to those who choose to participate in them. On the other hand, there are certain disadvantages to these types of savings plans. Your contribution decision should be based on adding up the pluses and minuses, and seeing which comes out on top.

The Positives

Contributions to a 401(k) plan by the employee are made on a pretax basis (although some plans allow for additional contributions on an aftertax basis). Pretax contributions are those that are taken from your salary before income taxes for the year are determined. The result is a lower tax bill in the year that contributions are made.

This doesn't mean that the contributions are tax-free. Instead, you pay taxes when the money is withdrawn from the plan, usually at retirement. In other words, taxes on your contributions and on the earnings (interest, dividends and capital gains) are deferred. However, the money builds up more quickly than would be the case if you invested aftertax money and paid taxes each year on the earnings.

The tax-deferral aspect also gives you flexibility to determine the best time to pay the tax, with the possibility that when you eventually do pay taxes, it will be at a lower rate.

The other major advantage of many 401(k) plans is employer-matched contributions. For instance, an employer may contribute $0.50 for every $1 that you contribute to the plan. This is an obvious advantage-you are earning 50% on your contribution before you have even invested it anywhere.

This advantage depends in part on any cap the employer may have on the match. And the advantage depends on the employer's vesting requirements. Vesting is the right an employee gradually acquires to receive employer-contributed benefits, and is based on the length of time employed. The faster vesting requirements can be met, the more advantageous the employer match, unless you plan to stay with the company (or have been with the company) for the full vesting time period.

There are several other important advantages offered by 401(k) plans:

• Flexibility: You can determine the amount you are able to contribute, and you make the decisions as to where your money is invested among the available investment choices.
• Portability: If you should leave your employer, any contributions you have made to your plan, as well as their earnings, are yours; vested contributions made to your plan by your employer are also yours.
• Periodic investing made easy: An automatic deduction from your paycheck each month allows you to gradually build up your investment without having to make big financial sacrifices.

The Negatives

These advantages are strong arguments in favor of participating in your company's 401(k) plan. But you do need to be aware of the disadvantages.

Limited Access

If you contribute to a 401(k) plan, you will have limited access to your money without costly penalties for a long period of time-until you leave your employer or reach the age of 59½.

If you remain with your employer, access to your 401(k) money isn't entirely restricted, just limited: Some plans allow participants to borrow funds from their 401(k) plan assets, usually at an intermediate-term market rate. However, loans that are not repaid within the restricted time period are considered distributions, with taxes and a 10% early withdrawal penalty due. In addition, some companies will permit withdrawals from a 401(k) plan due to severe financial hardships. However, anyone requesting part or all of their dollars under this clause must show their employers that they have exhausted all other non-retirement financial resources, and the withdrawals are also subject to the 10% early withdrawal penalty and, of course, income taxes.

These features are comforting for short-term emergencies, but you will have lost the primary advantage of the plan. To take full advantage of your employer's 401(k) plan, you should consider money invested in the plan to be long-term savings.

If you leave the company and you have not reached 59½, you can take a lump-sum distribution of your 401(k) plan money to spend as you wish, but only by paying a 10% early withdrawal penalty and, of course, taxes. You can avoid the penalty only by rolling your money over into an IRA or a new employer's qualified plan.

Limited Choices

A second possible drawback is that you are limited to the investment choices provided by the employer. This may or may not be a negative. Most employers provide at least one form of investment in three broad asset categories-cash, bonds, and stocks. And many employers provide a number of choices within those categories. But if you are uncomfortable with or strongly dislike your employer's selection(s), you may want to consider an alternative savings vehicle.

The Decision = Adding It All Up

For most individuals, the positives of contributing to your employer's 401(k) plan will outweigh the negatives. But make sure you do the math to make sure it all adds up.

© 2010 AAII Journal

 

Loans from 401(k) Plans: How Many, How Large?

WASHINGTON-How many participants have taken loans from their 401(k) plan? How large are those loans?

The latest update of the EBRI/ICI database shows that, at year-end 2008, less than one-fifth of participants had loans from their 401(k) plan. The average loan balance was down at the end of 2008 compared with year-end 2007.

The details:

• Among participants with outstanding 401(k) loans at the end of 2008, the average unpaid balance was $7,191, compared with $7,495 in the year-end 2007 database. The median (mid-point, half above and half below) loan balance outstanding was $3,889 at year-end 2008, compared with $4,167 in the year-end 2007 database.
• With account balances generally pulled down by the stock market in 2008, the ratio of the loan outstanding to the remaining account balance edged up in 2008, although within ranges seen in other years of analysis. Similar to year-end 2002, loan balances as a percentage of account balances (net of the unpaid loan balance) for participants with loans was 16 percent at year-end 2008.
• Fifty-nine percent of the 401(k) plans for which loan data were available in the 2008 EBRI/ICI 401(k) database offered a plan loan provision to participants. The loan feature was more commonly associated with large plans (as measured by the number of participants in the plan). Ninety-three percent of plans with more than 10,000 participants included a loan provision, compared with 33 percent of plans with 10 or fewer participants.

Note: Average and median 401(k) loan amounts are calculated among participants with 401(k) loans. The EBRI/ICI 401(k) database, the largest of its kind, is a joint project of the nonpartisan Employee Benefit Research Institute (EBRI) and the Investment Company Institute. Additional information about 401(k) loan activity, asset allocation, and account balances appears in the October 2009 EBRI Issue Brief, available at www.ebri.org

Employee Benefit Research Institute
© 2010 Employee Benefit Research Institute
http://www.ebri.org

401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2008

Because 401(k) balances can fluctuate with market returns from year to year, meaningful analysis of 401(k) plans must examine how participants' accounts have performed over the long term. Looking at consistent participants in the EBRI/ICI 401(k) database over the five-year period from 2003 to 2008 (which included one of the worst bear markets for stocks since the Great Depression), the study found:

• After rising in 2003 and for the next four consecutive years, the average 401(k) retirement account fell 24.3 percent in 2008.

• The average 401(k) account balance moved up and down with stock market performance, but over the entire five-year time period increased at an average annual growth rate of 7.2 percent, attaining $86,513 at year-end 2008.

• The median (mid-point) 401(k) account balance increased at an average annual growth rate of 11.4 percent over the 2003-2008 period to $43,700 at year-end 2008.

THE BULK OF 401(K) ASSETS CONTINUED TO BE INVESTED IN STOCKS. On average, at year-end 2008, 56 percent of 401(k) participants' assets were invested in equity securities through equity funds, the equity portion of balanced funds, and company stock. Forty-one percent was in fixed-income securities such as stable-value investments and bond and money market funds.

THREE-QUARTERS OF 401(K) PLANS INCLUDED LIFECYCLE FUNDS IN THEIR INVESTMENT LINEUP AT YEAR-END 2008. At year-end 2008, nearly 7 percent of the assets in the EBRI/ICI 401(k) database were invested in lifecycle funds and 31 percent of 401(k) participants held lifecycle funds. Also known as "target-date" funds, they are designed to simplify investing and automate account rebalancing.

NEW EMPLOYEES CONTINUED TO USE BALANCED FUNDS, INCLUDING LIFECYCLE FUNDS. Across all age groups, more new or recent hires invested their 401(k) assets in balanced funds, including lifecycle funds. At year-end 2008, 36 percent of the account balances of recently hired participants in their 20s were invested in balanced funds, compared with 28 percent in 2007, and about 7 percent in 1998. At year-end 2008, almost 23 percent of the account balances of recently hired participants in their 20s were invested in lifecycle funds, compared with almost 19 percent at year-end 2007.

401(K) PARTICIPANTS CONTINUED TO SEEK DIVERSIFICATION OF THEIR INVESTMENTS. The share of 401(k) accounts invested in company stock continued to shrink, falling by nearly 1 percentage point (to 9.7 percent) in 2008. That continued a steady decline that started in 1999. Recently hired 401(k) participants contributed to this trend: they were less likely to hold employer stock.

PARTICIPANTS' 401(K) LOAN ACTIVITY WAS STABLE. In 2008, 18 percent of all 401(k) participants eligible for loans had a loan outstanding against their 401(k) account, the same percentage as at year-end 2007 and year-end 2006. Loans outstanding amounted to 16 percent of the remaining account balance, on average, at year-end 2008; this is similar to the year-end 2002 level.

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Employee Benefit Research Institute