All about autos: the why and how of making saving for retirement easy

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When employers started adding automatic enrollment to retirement plans nearly 20 years ago, many hailed it as the cure-all to getting reluctant, overwhelmed or otherwise disengaged employees to take that first step toward retirement security. Fast forward to 2024 and plan sponsors widely embrace automated features to help employees make other plan decisions that often stop them in their tracks: how to save more through auto increase and what to do with their savings when they leave the company through auto portability. Thanks to recent legislation, employers can take all we’ve learned about automatic features to help with the more important decision: how to make employees’ savings last through retirement.

Why auto features work

It’s well documented that workers want to make as few active decisions regarding retirement saving as possible. Data shows that over 83% of participants stick with the default investment in their retirement plans, and half of participants are only invested in only one fund.¹

One of the advantages of driving automatic plan attributes is that it helps overcome participant behavioral bias and inertia. We know that many people will just do the default, as it reduces overall cognitive load, especially during the early stages of a career when an employee is more focused on other matters (see our Benefits 2.0 article in this edition). This inertia bias means that plan sponsors have a significant responsibility to construct plan design around auto enrollment and auto escalation responsibly and in a way to maximize engagement but doesn’t drive participants to opt out. TIAA research shows that light touch interventions can increase retirement savings by 20-70 basis points, while automatic enrollment increases participation by 37%.²

The social proof of seeing others contributing to plans is a useful tool as well. Encouraging healthy behaviors by showing that others are engaging in those behaviors is a well-recognized method of encouraging change. 

However, the plan sponsor still needs to take a more active role to get participants into the plans and making sure those savings are adequate. Changes in legislation have followed on from academic behavioral studies, with the Pension Protection Act of 2006 and elements of the SECURE Acts 1.0 and 2.0 both being developed after advances in the academic literature around encouraging participants to save.³ The provisions, outlined below, begin in earnest in 2025, but now is the time to be readying.

For plans started after December 2022 and for new plans to be introduced in 2025, the new rules mandate that there is an initial auto contribution rate of at least 3%, but not more than 10%. The plans must also automatically escalate until participants are contributing at least 10% but not more than 15%. Employees may opt out of either or both of these auto provisions.⁴

Studies show that over half of plan sponsors are currently using auto enrollment to get participants into their plans, while a quarter are already automatically increasing contributions.⁵ The changing regulatory environment should drive these percentages higher, but the value has already been identified by many plan sponsors.

Auto portability

It has long been a weakness of the 401(k) system that assets are often stranded when an employee moves to a new company. This especially impacts lower paid participants, as they are most likely to have lower balances that are automatically paid out (if the balance is under $5,000), who are then more likely to not reinvest those assets in a qualified account, losing a number of retirement savings benefits. There are also employees with multiple accounts spread across previous employers, which is itself suboptimal from an asset allocation and fee optimization perspective.⁶

The SECURE Act 2.0 took steps to help alleviate some of this, in lockstep with a number of record keepers and a technology firm, to help automatically roll prior account balances into a new employer’s retirement scheme.⁷ This is a definite area of focus in 2024 for regulators, with the head of the Employee Benefits Security Administration saying, “there is a particular need for automatic portability solutions that help ensure participants remain connected to their retirement savings when they change jobs.”⁸ Automatic rollovers encourage participants to stay invested, take an additional set of steps out of the process of starting a new job, and especially help employees who are lower paid or who might not know what to do with their accumulated savings from prior employers.

How it works

There are obviously some considerations when determining the initial level of autoenrollment and where to escalate up to. It can be difficult for employers to pick the default contribution rates, with the risk that if a rate is chosen that is too high, participants may feel the need to opt out in order to protect their take-home pay levels. However, there are also arguments to be made that starting at a much lower level, such as 3%, is too low as it takes too long to get up to a more impactful level, closer to 10%, thus many participants wouldn’t be saving enough for those interim years.

The right balance might be to start the default contribution level at the level at which the company matches contributions, thus ensuring that employees are at least taking advantage of the additional contributions that the company is willing to make. The most common matching formula, affecting 72% of plans and 62% of participants, is $0.50 per dollar on 6% of pay.⁹ Plan sponsors have to balance the need to boost the retirement savings of participants against an underlying philosophical appearance of paternalistic behavior toward employees and forcing them into certain types of behavior. 

The cost of whether to autoenroll or let participants make the active decision is also a major consideration for plan sponsors, with data showing that active choice is most cost effective for small and some medium companies, while autoenrollment is often most cost effective for larger companies.¹⁰

What’s next: Default investments with lifetime income

Building lifetime income into the decumulation stage of the plan would be the culmination of the automation of a retirement plan. This would complete the employee’s cycle, autoenrolling them into the plan, autoescalating to the most effective savings rate, and then creating an automatic allocation to an annuity that would allow the participant the optionality to automate lifetime income upon retirement. The SECURE Act set this process in motion when it included safe harbor provisions for annuities within retirement plans.

This automatic allocation to an annuity product, and the automatic payments for the lifetime of the annuitant, would help alleviate the stress of participants by guaranteeing minimum income levels over and above Social Security payments. This peace of mind, both building in the allocation to annuities to increase familiarity during accumulation, and the guaranteed income offered at retirement, can help participants feel more comfortable with their situation.

Human resources considerations

There are other secondary benefits that follow on from the introduction of automation as well. At a time when benefits offerings are increasingly under scrutiny from potential employees (see Benefits 2.0 article in this edition), having automatic enrollment and escalation features that go above and beyond statutory requirements and that are clearly communicated to employees can be a powerful tool for a people team to engage with new employees.

Taking the stress out of onboarding by automating much of the process can also work to reduce manual processing that comes with new employees and managing retirement plans.

One further advantage of autoenrollment and autoescalation is that it can help with nondiscrimination testing. While many larger companies will have processes in place to pass these tests, companies that may have fewer employees at different compensation levels need to be more aware of the testing requirements.¹¹

Employers setting up retirement plans for the first time can also claim tax credits to offset the cost of doing so. These costs, depending on who is in the plan and how it is set up, can be up to $5,000, and a plan that is set up with autoenrollment features can be eligible for a $500 tax credit per year for a three-year period after the feature is added to the plan.¹²

One other point is that these features don’t particularly contribute to participant education and engagement with financial literacy and readiness. However, with the key plan decisions well in hand, employers and employees alike can focus on much more important topics, namely why they should keep their money in the plan and how to set themselves up for better overall financial well-being.

The combination of benefits for the company and for the employees should make automatic features a significant area of focus for sponsors this year, both because of the regulatory pressure to do so, but also because of the positive effect including such provisions can have.

Behavioral science and three benefits of annuities

1. Being happier
   Interestingly, for retirees with guaranteed lifetime income, their retirement satisfaction holds steady over time; for those without, that satisfaction typically decreases with age.¹³ The decline makes sense, says Surya Kolluri, head of the TIAA Institute. One-third of today’s 65-year-olds will live to age 90, he explains, and one in three will experience cognitive decline after reaching 85. “You’re more prone to making financial mistakes if you’re dealing with cognitive decline,” he says. “Having guaranteed lifetime income allows you to move past that and not have to worry about managing your portfolio.” 
2. Living better
   You don’t need a PhD in psychology to understand why a retiree might be less stressed if they know they won’t run out of money. But annuities’ happiness advantage is about more than just avoiding a worst-case scenario. It’s about retirees feeling more free to live their best lives. When retirees know their basic needs are taken care of, it’s easier for them to splurge on the things they love. They don’t forgo an extra vacation with the grandkids for fear they’ll run out of money should they live to 100.¹⁴
3. Being healthier
   Long before scientific research showed annuities might be good for you, 19th-century novelist Jane Austen considered this an open secret. In “Sense and Sensibility” Mrs. Dashwood tells Mr. Dashwood: “People always live forever when there is an annuity to be paid them.” People with annuities don’t actually live forever, of course. But they do tend to live longer, studies show. According to a 2018 article in the Journal of Financial Services Professionals, a 65-year-old male in the U.S. who purchases a life annuity can expect to live about 20% longer than a 65-year-old male who doesn’t.¹⁵ The traditional explanation for why people with annuities live longer has less to do with the annuities themselves than with those who purchase them. But there may be an additional explanation for the extended longevity among those receiving lifetime income: reduced stress. We know a majority of Americans are stressed about retirement savings.¹⁶ Research also shows a strong correlation between high stress and reduced life expectancy, particularly among the elderly.¹⁷