Even though an automatic salary deferral rate of 3 percent into an employee's 401(k) is not enough to get them where they need to be in retirement, most companies are not poised to raise their initial default rate above that figure.
David Wray, president of the Plan Sponsor Council of America, says that the "3 percent initial default rate for automatic enrollment seems to be pretty steady. They've been doing this a long time. Companies that were defaulting at less than 3 percent are now coming up to 3 percent."
He added that, "we don't see the trend of people moving from 3 percent forward. What they are doing is escalation instead. You could automatically enroll people at 6 percent. That's exceptional, but I don't see it trending in that direction."
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Plan sponsors that add an escalation feature to their plans will bring employees up to higher savings amounts over time, but "I think the collective decision of the community at the moment is that when you have a new person, a new hire, 3 percent seems to be what everyone is comfortable with. Maybe that number will change, but that is where we are," Wray said.
A recent survey of small and medium-sized employers across the United States found that 66 percent of employers who offer 401(k) plans would be willing to improve education to promote double-digit savings levels among their employees. The "2011 Principal Financial Group Retirement Readiness Survey" also found that 40 percent of plan sponsors would consider a 6 percent or 8 percent default deferral rate for workers who are auto-enrolled in their plan; and 32 percent of employers who use auto-enrollment said they would be willing to combine a 6 percent deferral rate with a 1 percent auto increase up to 15 percent if shown research that participants wouldn't opt out.
Unfortunately, 401(k) participants are not investors. For the most part, they don't get up in the morning and read the Wall Street Journal, Wray said.
"They don't like investing. They are doing this because their employer is telling them this is important and they know in their gut they should save for retirement," he added.
There are always those select few participants who actively manage their accounts, but most rely on their employers to make the big decisions for them and provide easy menus, a simple framework and assistance, he said.
The reason most employers who offer retirement plans offer automatic enrollment programs, with default deferral rates, is that many employees would do nothing to save for retirement if they didn't. Experts agree that most plan participants are so hands-off they wouldn't even take the time to opt out of their plan's automatic deferral program. That is why it is critical for plans to consider raising the deferral rate above 3 percent, Wray said.
Many employers match their employee contributions by a certain percentage. If employers match their employee's 3 percent 401(k) contribution at 50 percent, that brings their savings total to 4.5 percent, which is not enough to retire on, he said. "The point is to initiate the process. That's why escalation is so important."
Saving for retirement is hard, particularly for employees experiencing life-changing events, like getting married, having children, purchasing a home or paying off student loans.
"It is the lowest point in their compensation history and yet it is the most critical time for them to save," Wray said. The point is to get started and work up over time. "Historically, people save significantly more when they reach 45," he said. But if employees save and invest even a little bit between the ages of 25 and 35, they will have as much in retirement savings as someone who didn't start saving until they were between 35 and 60, the higher earnings years.
"The power of compounding is really profound. People don't appreciate that. It is a hard thing to grasp, especially when you are young," Wray said.
Financial education is the key to success in defined contribution plans, according to Liz Davidson, CEO of Financial Finesse. Research by the financial education company found that 92 percent of employees who participate in retirement education make a major change to their retirement plans within 30 days of receiving the education. Workers change what they are investing in, increase their deferral rate or open up an IRA to supplement their company-sponsored plans.
The better educated employees become, the higher their 401(k) deferral rates.
Wray agreed that financial education is important to boosting plan deferral rates, but communications programs need to be repetitive.
Successful programs with high participation and savings rates have plan sponsors who periodically remind their employees that they need to save.
"It is a matter of being persistent," he said.
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