Equalizing Retirement

Auto enrollment is effective in putting more minorities into their company's 401(k) plans, but employers need to be even more aggressive, by escalating contribution rates, experts say. Otherwise, employees -- especially lower-paid workers -- just won't be able to have money that will last through retirement.

Thursday, November 10, 2011
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When it comes to racial and ethnic differences in retirement-savings behaviors, automatic enrollment appears to be the great equalizer.

So says a recent study by Valley Forge, Pa.-based Vanguard entitled Diversity and Defined Contribution Plans: The role of Automatic Plan Features. While many studies have found racial differences in savings and investing behavior, this is the first time researchers have looked specifically into the impact 401(k) and other defined-contribution plans have on these behavioral disparities.

"[This] study confirms that the use of automatic-plan-design features do, indeed, reduce racial and ethnic disparities," according to Vanguard.

Specifically, researchers sampling seven large DC plans found participation rates for blacks rose from 57 percent to 94 percent after automatic enrollment, and 67 percent to 95 percent for Hispanics -- thereby eliminating most group differences. (Interestingly, regardless of the enrollment method, Asians participate in retirement plans at a higher rate than all other groups.)

The researchers also found automatic enrollment into target-date funds equalizes equity risk-taking among all groups.

About 75 percent of blacks and Hispanics remained in the default fund after automatic enrollment, compared to 68 percent of whites and 60 percent of Asians.

Whites and Asians, the reports states, tend to override the deferral default more -- at rates about 0.5 percent to 2 percentage points higher than for blacks and Hispanics -- due to a tendency toward more aggressive equity and asset allocations.

"Since [blacks and Hispanics] are more likely to remain at plan defaults," the researchers write, "the burden falls on the sponsor to ensure that default choices are appropriate for building adequate retirement savings over time.

"In particular, we suggest setting higher initial default-contribution rates ... and augmenting automatic enrollment with an automatic-escalation feature to reduce differences in retirement-plan deferrals over time."

Vanguard researchers also urge employers to use target-date funds "to reduce differences in average investing behavior and the incidence of extreme portfolios."

Pamela Hess, director of retirement research at Lincolnshire, Ill.-based Aon Hewitt, couldn't agree more. Employers, she says, are far, far from where they need to be in encouraging the kinds of savings practices and behaviors that will truly help people into and through retirement.

"One of the biggest concerns we have," says Hess, "is the number of companies that are only defaulting new hires."

A July 2011 Aon Hewitt study, entitled Trends and Experience in Defined Contribution Plans: Paving the Road to Retirement, found that, out of the 57 percent of companies now using automatic enrollment, 46 percent are only defaulting new hires, while 11 percent are defaulting both existing employees and new hires.

Equally concerning in the study -- which surveyed 546 U.S-based employers with a combined total of 12 million employees and $780 billion in assets -- are the low numbers of companies using automatic escalation every year: a meager 2 percent or 3 percent, says Hess.

"We need to be thinking higher, like 10 percent," as a default contribution, she says.

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"We have looked at 3, 4, 5, 6 and 8 percent defaults and have found the different numbers don't change the rate of opting out [by much]," says Hess. "These numbers need to be raised. You're sending a powerful message.

"I think many employers are afraid their people will be upset [if they automatically enroll them at something higher than 3 percent], but [raising the rate] is such a good message: 'We're worried about you, and we want to be sure [you] can retire one day.' "

If companies are concerned about the cost of matching their contributions, she says, they should "change the match formula; make it 50 cents for every dollar or 25 cents for every dollar. At least that way, you're getting more of their income put away for retirement and not breaking the company's bank or capabilities to help." 

Hess adds that most employers using automatic escalation, "will do so every two or three years."

In a perfect world, she says, all employers would escalate all employees every year. Otherwise, she says, it " is going to take years, decades, to get [workers] where we need to be, [and] to have a really profound impact on people who are in those [lower-earning] jobs."

The fact that women and some minorities save far less than whites and Asians, she says, "comes down to two factors -- the ethnicities factor and the compensation factor -- because, clearly, when you look at savings behavior, people who earn less save less."

"Overall, [data bears out] that minorities, including women, make less and therefore save less," she says. "So automatic enrollment is very powerful [for these employees]."

One encouraging sign is the number of companies automatically enrolling employees into target-date funds. The Vanguard study finds 78 percent of respondents default participants' funds into target-date funds, up from 69 percent in 2009 and 50 percent in 2007.

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