While there’s much debate over the pros and cons of auto-features and whether participants need a nudge, the results of a new study suggest that plan sponsors can, in fact, boost “default escalators” in 401(k) plans without decreasing participation.
The results arise from a new field study conducted through the Voya Behavioral Finance Institute for Innovation, which set out to find the optimal retirement plan design settings for automatic escalation and how it affects participant decision making.
According to the research conducted in collaboration with Carnegie Mellon researchers Saurabh Bhargava, Richard Mason and Mark Patterson, and Shlomo Benartzi at UCLA, nearly all individuals who enroll in auto-escalation choose to keep the default a 1% escalation.
In fact, the most common default escalator employers currently choose in their plan design is 1%, but in many cases, an increase of 1% is still not allowing individuals to reach their maximum retirement savings potential.
So the question for employers is what happens if they increase the escalator from 1% to 2%? And does accelerating the pace of escalation lead some enrollees to save more faster or does it lead to an increase in those declining enrollment?
To further understand the impact of leveraging different auto-escalator settings, the study experimentally varied plan enrollees’ views of 1% or 2% default auto-escalation rates and whether the start date of the escalation was a year, six months or three months.
The researchers randomized the default auto-escalation options displayed to 22,170 new 401(k) enrollees across 398 plans. Note also that these plans used an opt-in enrollment process where employees had to choose whether they save and whether they want auto-escalation (different from automatic enrollment plans, where employees are often automatically assigned escalation features).
The results indicate that an opportunity exists for employers to increase the default to 2% without significantly decreasing employee participation in the escalation feature of the plan. In this case, the research found:
- Those who enrolled at a default of 1% remained at this escalation without a consideration of an increase.
- Among the employees who were shown a 2% default escalator and decided to participate in auto escalation, roughly half ultimately stuck with the default 2%.
- The majority of the remaining individuals who were enrolled at 2% switched back to 1% but still chose to escalate.
- The higher default escalator of 2% did not meaningfully increase the number of employees who initially declined auto-escalation altogether.
“We live in a world of ‘auto-everything,’ which has helped to provide greater opportunity for individuals to be saving more for their future,” said Tom Armstrong, head of Voya’s Behavioral Finance Institute for Innovation. “But by helping workers get to the right savings rate in less time, employers have a real opportunity to design auto-escalation processes that help employees be more prepared for retirement.”
Voya’s research also found that, among employees who decided to enroll in automatic escalation, a significant amount of them were also willing to escalate before 12 months had elapsed. In fact, when prompted by the default, more than half (54%) appeared willing to escalate in 90 days and nearly 7 in 10 (67%) in 180 days.
One caveat is that the more aggressive default delays, which led to escalation beginning sooner, did modestly reduce escalation enrollment from 23% to 18%, the research shows.
The key takeaway, according to the paper, is that, instead of setting default escalation increments at 1%, plan sponsors may be able to set them at 2% without significantly decreasing participation. And, while plans can also accelerate the pace of saving by setting their auto-escalation defaults to begin sooner, they should address the potential for lower enrollment.
“Ultimately, our findings also highlight the need for additional research to help determine the optimal escalation default for different types of employees,” added Armstrong. “By creating more personalized defaults and in striving to optimize the design of retirement savings products, employers should not overlook the importance of appropriately setting and personalizing auto-escalation defaults.