401(k) Match Thresholds and Default Rates Affect Savings

There are several levers to increasing contribution rates, including 'stretch matching'

By Stephen Miller, CEBS May 20, 2013

"Automatically enrolling employees into a 401(k) plan at a 6 percent salary default rate, rather than at the more common 3 percent default, means a higher savings rate for more people," said Dallas Salisbury, president and CEO of the nonprofit Employee Benefit Retirement Institute (EBRI), at a May 9, 2013, EBRI-sponsored policy forum on how plan design decisions affect adequate retirement savings, held in Washington, D.C. "It's more effective than encouraging greater savings through communications and education."

"Participants look at the default rate and say, ‘My employer is telling me 3 percent is a good place to be,’" said Dan Campell, the leader for consultancy Aon Hewitt's defined contribution practice.

"In the end, a majority will be led to success or failure based on plan design," concurred Stacy Schaus, executive vice president and leader of investment firm PIMCO's defined contribution practice. "Let's get the defaults right because that's where people are most likely to stay."

According to Schaus, critical plan aspects include:

  • Getting people into the plan.

  • Escalating their savings rate over time.

  • Encouraging broad diversification to reduce portfolio risk, through strategies such as investing in target-date funds that shift to less-volatile assets as the designated retirement date nears.

  • Communicating the importance of staying the course and remaining invested despite short-term market volatility.

Campell said Aon Hewitt's research shows that 70 percent of large plans have adopted automatic enrollment. Of these, 52 percent also have automatic escalation, and most of these (64 percent) escalate in 1 percent annual increases, up to 10 percent of deferred pay.

There are outliers, however: 8 percent of plans with auto escalation will raise rates up to a target default of 15 percent of pay; another 8 percent use a target default of 25 percent of pay.

Stretch Matching

"For the most part, plan sponsors are saying that the optimal savings rate would be at least 10 percent of pay, including the plan sponsor and participant contributions. And yet that's not how most plans are structured from a behavioral standpoint," said Lori Lucas, executive vice president and defined contribution leader at consultancy Callan Associates.

Studies have found that the the typical match is 50 percent on the dollar, up to 6 percent of a participant's deferred pay. As noted, the typical automatic enrollment default rate is only 3 percent of deferred pay. "That's not going to get participants up to a 10 percent savings rate if that's where they stay," Lucas said.

In addition to auto enrollment, there are several levers to increasing contribution rates, including "stretch matching," she noted. A stretch match involves raising the match threshold from, say, 6 percent to 10 percent of deferred pay. To keep the employer's contribution cost neutral, plan sponsors would reduce the match amount from 50 percent on the dollar to something less.

Lucas discussed findings by researchers led by James Choi at Harvard University that showed the following: Company A offered voluntary enrollment and no employer matching contribution. It then introduced a match with a threshold of up to 4 percent of deferred pay. Soon after, participant contribution rates tended to cluster at the new 4 percent match threshold.

"People were saving to the threshold, which tended to pull up those saving less than 4 percent but also pulled down some of those saving more than 4 percent," Lucas said.

In another Harvard research finding, Company B offered a matching contribution in a range of 25 percent to 100 percent on the dollar (depending on the division in which an employee worked), up to a match threshold of 6 percent of deferred pay companywide. Regardless of the percent on the dollar matched, deferral rates peaked at the 6 percent match threshold, again showing a cluster effect.

'Paper, Rock, Scissors': Auto Enrollment Beats Match Threshold

The Harvard researchers next looked at auto enrollment plans with varying matching structures. In one telling example, when auto default was set at 3 percent of pay, most participants were clustered at the 3 percent rate despite a 4 percent match threshold.

When auto default was set at 3 percent of pay,
participants clustered at the 3 percent rate
despite a 4 percent match threshold.

"There is evidence that the match threshold, while powerful under voluntary enrollment, loses a lot of its power under auto enrollment," Lucas said. "In the game of paper, rock, scissors, default contribution rates beat match thresholds in terms of influencing savings behavior. The default savings rate under automatic enrollment is a very powerful motivator."

Getting Creative

Plan sponsors can better design their plans to promote participation and savings rates while controlling employer costs, Lucas pointed out. For example, Company C has auto enrollment, and its plan is structured as follows:

  • A 100 percent employer match on the first 1 percent of a participant's deferral from pay.

  • A 50 percent match on the next 5 percent of deferrals.

  • A 4 percent non-elective employer contribution (creating a "floor" for all employees, including those unable to save enough for the full match).

  • Auto enrollment at 6 percent of pay.

  • Auto escalation increase of 1 percent annually, up to 10 percent of pay.

Plan design should take into consideration employee demographics and income, along with the amount the employer is willing to contribute as participation rises through auto enrollment and auto escalation.

"Plan sponsors can keep costs down and facilitate more robust savings in auto enrollment plans by getting creative" with the match and other design elements, Lucas advised. "You can jiggle these numbers around and do different things to get to a cost-neutral state without sacrificing the default level"and the higher participant savings rate it can drive.

Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related SHRM Articles:

Changes in 401(k) Plans Spur Higher ParticipationSHRM Online Benefits, October 2012

401(k) Match Thresholds Drive Participation More than RatesSHRM Online Benefits, July 2012

Encourage Employees to Defer Adequate Pay to Their 401(k)SHRM Online Benefits, May 2012

Educate on 401(k) Contribution Limits and Matches, SHRM Online Benefits, March 2012



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