Grant’s Go-To’s: Automatic Enrollment and Escalation

Anyone working on a state-facilitated auto-IRA program has probably been asked at some point why a state should offer a savings product already available through banks, credit unions and other financial institutions. The answer? State-facilitated programs – whether auto-IRAs, MEPs or Marketplaces – are designed to significantly increase retirement savings by reaching workers at the workplace and by including automatic features that make participation more likely.  

Behavioral economists suggest people fail to save for retirement because of inertia and because of shortsightedness that leads most of us to value immediate gratification over the long-term benefits of saving now for the future. These are precisely the obstacles workplace automatic enrollment plans are designed to overcome.

Research provides convincing evidence in support of workplace plans with automatic features. An often-cited 2016 AARP article, for example, suggests workers are 15 times more likely to save for retirement if they have access to a savings plan at work. A 2018 PEW Trusts report on automatic enrollment points to Vanguard data indicating 92 percent of employees participated in automatic enrollment plans, while only 57 percent enrolled in voluntary plans. Even though state-facilitated auto-enrollment programs that lack employer matching contributions might not achieve the same levels of participation, the findings nonetheless highlight the effectiveness of automatic enrollment when it comes to increasing savings behavior.

For programs that enroll participants automatically, a key decision to consider is where to set the default contribution rate for employees who do not make an active choice about how much to save. The optimal default rate should be set high enough to generate savings, but not so high that it will cause people to opt out.

One downside to default contribution rates is that they tend to be “sticky.” According to a 2015 Harvard student publication, studies have shown that many employees remain at the default rate specified in the plan, including some who might have otherwise chosen a higher savings rate if they had opted into the plan. In order to encourage increased savings, some state programs have included escalation features that automatically increase contributions until they reach a predetermined maximum level. As with the initial default contribution rate, participants can opt out of automatic escalation.

The table below summarizes the various state approaches with respect to automatic enrollment, default contribution rates and automatic escalation.

Given that people tend to take the path of least resistance when it comes to retirement savings, states with retirement savings programs and initiatives should be applauded for paving that path in a direction that leads to greater participation and savings.

In the next edition of this column I plan to explore the range of investment options state-facilitated programs have adopted.

Stay tuned! - Grant

This piece was featured in the March 11, 2021 edition of Retirement Security Matters. For more fresh thinking on retirement savings innovation, and for a shot of John shucking oysters, check out the newsletter here.