401(k) auto-enrollment less effective than expected, study says

Employers are increasingly putting employee 401(k) plan savings on autopilot.

But the positive impact of automated pension savings is smaller than initially thought, new research shows.

Previously “under-exposed” factors — such as workers cashing out 401(k) balances when they leave a job — “meaningfully reduce” the long-term impact of policies like auto-enrollment and auto-escalation, according to a new paper published by the National Bureau of Economic Research.

Importantly, some of the paper’s co-authors – James Choi of Yale University, and David Laibson and John Beshears of Harvard University – are behavioral economists who have done groundbreaking research on the positive effects of automatic enrollment.

“They look like the OGs [originals]says David Blanchett, head of pensions research at PGIM, an investment manager. “These are the people who have been researching this topic for decades now.”

Automated savings has been a cornerstone of 401(k) policy since Congress passed the Pension Protection Act of 2006.

Policies such as auto-enrollment and auto-escalation aim to increase the size of employees’ savings pots by automatically enrolling employees in their company 401(k) and then increasing (or ‘escalating’) their savings rate over time ‘).

In this way, people’s tendency toward inertia works to their advantage.

About two-thirds of 401(k) plans used auto-enrollment as of 2022, according to survey data from the Plan Sponsor Council of America, a trade group. Of these, 78% used automatic escalation.

Overall, their effect on savings is positive, “just not as positive as we had previously thought based on the research we had done previously,” Choi said in an interview.

The group’s first study did not track results for workers who left jobs where they were automatically enrolled.

This research update aimed to conduct a broader analysis, taking into account factors such as job turnover, Choi said.

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Overall, Choi and his co-authors recently found that auto-enrollment increased average 401(k) contributions by 0.6 percentage points of income over workers’ careers.

That’s a 72% drop in effectiveness from the 2.2 percentage point increase extrapolated by the “results of early breakthrough papers,” the paper said.

“You’re talking about 1.6% of income less saved per year,” Choi said. “If you add that up over a career of forty years, you are talking about more than half a year of saved income.”

When compound interest on those savings is also taken into account, it can make a “quite substantial” financial difference, he added.

The disparity is largely a function of so-called “leaks” from 401(k) plans. that is, withdrawing money early before retirement.

About 40% of employees leave a job payout their 401(k) plans every year, according to the Employee Benefit Research Institute. According to the most recent data from EBRI, this leakage amounted to $92.4 billion in 2015.

Employees can withdraw the money from the 401(k) plan before their employer match is fully vested, meaning they are giving up that free money.

Furthermore, only 43% of workers accepted an automatic escalation in their savings rate after a year, the National Bureau of Economic Research article found.

By comparison, early research by behavioral economists like Richard Thaler and Shlomo Benartzi estimated this share at around 85%.

In addition to automatic registration, job turnover also complicates automatic escalation, according to Blanchett of PGIM.

For example, an employee’s increased contribution rate could be reset to a lower savings rate if he or she were to join a new employer’s 401(k) plan.

While auto-escalation isn’t necessarily a reliable way to help people save more money, auto-enrollment has proven to be “very successful,” Blanchett said.

He believes the effectiveness of auto-enrollment should not be judged based on 401(k) leakage, which is a separate policy issue, he said.

“I think automatic enrollment does a spectacular job of getting individuals involved in the plan,” Blanchett said. “But we still have a huge leakage problem. It still exists whether you have auto-enrollment or not.”

That said, there is room for improvement with automated savings.

“I would like us to get to a point where 7% or 8% is the average standard savings rate,” Blanchett said.

Coupled with an employer match, the average worker would save 10% or more of their salary, something workers in general should strive for, he said.