The "Do Nothing" Default

There are countless statistics proving that Americans have not traditionally saved enough prior to their retirement years. Even though total assets in retirement accounts have now breached $26 trillion, the average employee’s 401(k) balance rests around $100,000, which is a little light for 30-40 years of retirement. In an effort to assist with this well-documented issue, regulators, retirement plan providers, and employers have joined forces in the last several years to change the status quo by adding automatic enrollment and automatic deferral escalation features into 401(k) accounts.

In the original 401(k) design, plan participants needed to make an active choice to join the plan. This positive election decision relied on employees to act in their own best interest by saving for their future. Sadly, we can now see many employees failed to take advantage of these employer plans. Studies in behavioral finance help provide a number of explanations.

Lack of planning skills make it difficult for certain employees to defer gratification. Simply put, some employees are not active, motivated decision makers when it comes to saving for their future so they end up focusing on today’s benefit in lieu of tomorrow’s payoff. Moreover, many of these individuals find retirement plans and investing to be complicated and confusing. When unsure how to proceed, people will often take the default or “no decision” choice. Unfortunately, within the voluntary savings plan world, the “no decision” choice is a decision not to contribute to the plan.

Inertia and procrastination are also powerful tools impeding would-be savers. Many participants deal with hard choices by deferring it to another day. Although most know they need to increase their retirement savings, they simply never get around to joining the plan or, if they do join, to increase their contributions over time.

The advent of the automatic enrollment plan has reframed the savings decision as a negative election. Under this arrangement, “doing nothing” leads to participation in the plan

and investment of assets in an appropriate age-based retirement portfolio. This approach is a burgeoning trend that now encapsulates about 60% of all retirement plans. In addition, many employers have taken steps to increase the automatic enrollment percentages upon enrollment and annually thereafter.

In the early years of auto enrollment, the most popular default deferral rate was 3% of compensation. Although some critics expected large opt out rates, recent studies prove that has not been the case. In fact, a recent study suggests that opt out rates don’t change dramatically until nearly a 10% deferral rate is attained. Emboldened by these analytics, more and more employers have been increasing the automatic enrollment rates to make the program more effective for their workers.

Few people enjoy being cajoled or manipulated into decisions. Though, when it comes to saving and investing for our retirement years, most employees need a boost. Left to their own devices, American workers have perennially put their retirement needs in the back seat. Automatic enrollment and automatic escalation plan design features are levers that employers can pull to enhance the financial health and betterment of their workers, which is win-win for everybody.