Study reveals that 401(k) auto-enrollment does not significantly increase savings as anticipated.

• 401(k) plan policies like auto-enrollment and auto-escalation have become popular.
• They aim to boost workers' retirement savings.
• Although pioneering researchers discovered that the policies may not be as effective as they initially believed, the effects are still positive, they stated.

More and more employers are automating the process of saving for their workers' 401(k) plans.

New research suggests that the positive impact of automated retirement savings may not be as significant as previously believed.

The new paper published by the National Bureau of Economic Research suggests that previously overlooked factors, such as workers withdrawing their 401(k) balances upon leaving a job, can significantly diminish the long-term effects of policies like automatic enrollment and automatic escalation.

Some of the paper's co-authors, including James Choi of Yale University and David Laibson and John Beshears of Harvard University, are behavioral economists who have conducted early research on the positive effects of automatic enrollment.

"David Blanchett, head of retirement research at PGIM, stated that "they are like the OGs [originals]" because "these are the people who've been doing research on this topic now for decades.""

'Not as positive as we had previously thought'

Since the Pension Protection Act of 2006, automated savings has been a key component of 401(k) policy.

The objective of policies such as auto-enrollment and auto-escalation is to increase the size of employees' retirement savings, by automatically enrolling workers in their company's 401(k) plan and then gradually increasing their contribution rate over time.

In this way, people's tendency towards inertia works in their favor.

According to a survey by the Plan Sponsor Council of America, 78% of the two-thirds of 401(k) plans that used auto-enrollment as of 2022.

"Although their effect on savings is positive, it is not as positive as we had previously believed based on our research," Choi stated in an interview.

The group's initial investigation failed to record outcomes for employees who left jobs with automatic enrollment.

Choi stated that this research update aimed to conduct a comprehensive analysis, taking into account aspects such as job turnover.

Some young adults are disconnected from the job market.

A recent study by Choi and his colleagues discovered that auto-enrollment increased the average 401(k) contribution rate by 0.6 percentage points of income throughout a worker's career.

The paper stated that the 2.2-percentage-point increase in effectiveness, which was extrapolated from early pioneering papers, resulted in a 72% decrease in effectiveness.

"Choi stated that if you were to add up the 1.6% of income less saved per year over a 40-year career, it amounts to more than a half year of income saved."

The financial difference can be "quite substantial" when compounding interest on savings, he stated.

The impact of 401(k) leakage

The significant difference between the two groups is mainly due to the early withdrawal of funds from 401(k) plans.

In 2015, $92.4 billion in 401(k) plan leakage occurred when about 40% of workers who left a job cashed out their plans, according to the Employee Benefit Research Institute's most recent data.

Employees can withdraw their 401(k) plan funds before their employer match is fully vested, resulting in forfeiting the free money.

The National Bureau of Economic Research found that only 43% of workers defaulted into auto-escalation of their savings rates, and after one year, they ultimately accepted a higher contribution rate.

Early research by behavioral economists like Richard Thaler and Shlomo Benartzi estimated that the share around 85%.

Blanchett of PGIM stated that job turnover makes auto-escalation more complicated, in addition to auto-enrollment.

If a worker joins a new employer's 401(k) plan, their escalated contribution rate may reset at a lower savings rate.

Blanchett stated that auto-enrollment has been "very successful" in encouraging people to save more money, although auto-escalation may not always be a dependable method.

He argues that the effectiveness of auto-enrollment should not be evaluated based on 401(k) leakage, which is a separate policy matter, he stated.

"Blanchett stated that auto-enrollment effectively enrolls individuals in the plan, but the leakage issue persists regardless of whether auto-enrollment is used or not."

That said, there's room for improvement with automated savings.

Blanchett stated that she would like to reach a point where the median default savings rate is either 7% or 8%.

A bar worker should aim to save at least 10% of their salary when paired with an employer match, according to him.