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Most Common 401(k) Savings Default Rate Rises to 6% of Pay

Higher default rates helped create record savings levels

January 19, 2022 | Stephen Miller, CEBS

A pink piggy bank next to stacks of coins and the word 40k.

401(k) savings rates hit record levels in 2021, thanks to higher default pay-deferral rates and automatically raising employees' contributions above the initial default level.

The most common 401(k) default deferral rate for automatically enrolled 401(k) plan participants is now 6 percent of an employee's pay, according to the recently released 64th Annual Survey from the Plan Sponsor Council of America (PSCA), based on responses from 518 plans.

For the first time, a 6 percent default rate was used by a plurality (33 percent) of surveyed plans, "rather than the 3 percent of pay that has been the norm since 2006," PSCA reported. A 3 percent default rate was used by 29 percent of plans, the survey found.

A Roth Account as the Default?

PSCA reported that just a handful of organizations (6.4 percent) have considered Roth after-tax contributions as the default deferral type for automatic enrollment. As one respondent opposed to the idea commented, "A Roth default could have negative tax implications for low-wage earners who are might otherwise qualify for the Earned Income Tax Credit. Also, by continuing to use before-tax as the default, we preserve the participants' ability to choose to convert the funds to Roth."

However, PSCA noted, "with the increased popularity of Roth … and the reconsideration of the tax benefits of pretax contributions, we may see some companies embracing Roth as the default in the future."

Default Rates & Matching Contributions

Selecting a higher default rate has a significantly positive effect on employee savings rates, according to a new research paper, The Impact of Employer Defaults and Match Rates on Retirement Saving, published Dec. 24 by the Social Science Research Network.

The study, by researchers at investment management firm QMA LLC, the American University and retirement plan record keeper Empower Retirement, evaluated the interaction between employer match and default rates on savings outcomes among approximately 157,000 401(k) plan participants.

"Selecting a higher default rate has the largest impact on employee savings rates," and is more significant than raising matching contributions when it comes to raising savings levels, the researchers found.

"Plans with low default rates that match a high percentage of employee earnings induce higher-income participants to actively move away from the low default savings rate, resulting in a wider savings gap between higher- and lower-income employees," they reported.

On the other hand, setting default savings rates at a higher percentage of pay drove up employee savings across income levels. "When employees are defaulted in at a higher rate, fewer move away from the default savings rate, resulting in higher and more equal savings rates among employees," the researchers said.

Escalating Savings Rates

"While raising the default savings level should increase savings rates for new participants, it won't necessarily help existing participants," the study noted, and plan sponsors may want to consider automatically enrolling current employees who are not participating in the plan. "Additionally, plan sponsors should also consider including provisions for automatic savings rate increases to further boost participant savings levels," raising employees' savings (as a percentage of pay) by 1 percent or more annually, the researchers advised.

Vanguard Investments similarly suggested in 2020 that "plan sponsors can seek to improve retirement outcomes through automatic enrollment combined with higher initial deferral rates, an automatic increase feature, and a total automatic increase cap of at least 10 percent."

Due in part to automatically raising contribution rates above the initial default level, Fidelity Investments' client data shows contributions to workplace retirement accounts hit record levels in 2021, with the average 401(k) contribution rate reaching a record 9.4 percent.

Companies Beef Up 401(k) Contributions

U.S. employers are sweetening 401(k) retirement plan contributions in a tight job market, The Wall Street Journal recently reported. "Employers are very nervous about this 'Great Resignation,'" Dave Stinnett, head of strategic retirement consulting at Vanguard Group, told the Journal.

Those taking action are typically boosting their match by one or two percentage points or are making one-time contributions on top of the match, Stinnett said. Others are allowing new hires to participate in the 401(k) plan immediately, rather than after a waiting period, or are reducing the time an employee must work before vesting in their employer's contributions.

"Some employers said boosting or instituting a 401(k) match was also a way to spread the fruits of higher profits because of an economy that was stronger than many business owners predicted in the early days of the pandemic," the Journal reported.

Spending Priorities

Increasing employer 401(k) contributions, however, must be weighed against other benefits and compensation priorities, advised Holly Verdeyen, a partner and U.S. defined contribution segment leader at HR consultancy Mercer, during a January Mercer webcast.

"The employer matching contribution into defined contribution plans is a significant annual spend for many organizations," Verdeyen noted. "In this current environment of higher wages and a greater focus on employee retention, it's a spend that potentially comes at the cost of investments in other areas, such as merit increases or tuition reimbursement programs."

Verdeyen urged plan sponsors to "measure and maximize" the value of that spending when setting priorities for the year ahead.