Auto-Enrollment Alone Can’t Fix Retirement Shortfalls: Research

What You Need to Know

These policies show promise, but a new analysis details their limits.
A large percentage of 401(k) balances are withdrawn upon employment separation.
Complementing auto-features with a holistic approach to promoting savings can have a bigger effect.

A new paper published by the National Bureau of Economic Research looks at the effect of automatic enrollment policies on retirement plan outcomes, and the results are likely to be disappointing to some.

While the paper emphasizes that auto-enrollment and auto-escalation of retirement account contributions have helped millions of Americans start on the savings effort, such features alone are insufficient to ensure positive outcomes.

Other dynamics seem to significantly undermine the long-term effect of automatic enrollment and auto-escalation on retirement savings when taken in isolation, both in the workplace and in the context of state-run retirement savings programs.

In particular, the analysis spotlights that employees frequently leave firms — often before matching employer contributions have fully vested. Further, a large percentage of 401(k) balances are withdrawn upon employment separation.

Many employees opt out of auto-escalation, according to the paper, such that steady-state saving rates increase by only 0.6% of income due to automatic enrollment and 0.3% of income due to default auto-escalation. Overall, only 40% of those with an auto-escalation default escalate on their first escalation date, and more opt out later.

An important caveat, the researchers note, is that the sample of retirement plans reviewed is small, so the estimated net effect of automatic policies would likely differ in a more representative sample.

“Nevertheless,” the team writes, “the high aggregate rates of employee turnover and pre-retirement leakage in the U.S. imply that our qualitative conclusion that employee turnover and pre-retirement withdrawals significantly undermine the positive effects of automatic savings policies would continue to hold at the population level.”

Such results should not necessarily be taken to suggest that automatic enrollment and escalation features lack utility. Instead, they underscore that the effort to save for retirement is part of a broader financial framework, one in which any single policy or strategy is likely to have only a limited effect.

How These Policies Work in Practice

The bulk of the paper is dedicated to examining a variety of scenarios based on nine real-world 401(k) plans, in which two populations of savers are examined — those who are indeed subject to automatic features and those who were hired before such features took effect.

As noted, the results of these scenarios show outcomes are determined by a variety of factors that, taken together, tend to overwhelm the effect of the auto-enroll and auto-escalate policies.

For example, in the first plan considered, the total impact on 401(k) accumulation from implementing auto-features is muted in part because the firm’s default contribution rate is a low 2%.

The Bottom Line

The authors assert that automatic savings policies have been widely adopted in part because of the strength of the empirical evidence that they increase retirement savings accumulation.

“When we jointly incorporate several medium- and long-run dynamic factors, we find that the magnitude of the savings effect is substantially diminished relative to previous estimates,” the authors conclude. “Nevertheless, we document that automatic savings policies have a positive statistically significant impact on measured savings.”

The effects that they estimate are modest in magnitude because of the increase in savings over time by those who are not subject to automatic policies, employee turnover rates, vesting requirements, cash leakage upon job separation and the low acceptance of auto-escalation defaults.

“Automatic savings policies are likely cost-effective from an impact-to-cost ratio perspective,” they add. “But if policymakers wish to effect larger changes in savings rates, reducing the liquidity of retirement savings before retirement and increasing compulsory savings may be more effective.”