FTFM Making membership of occupational pension schemes automatic is seen as a way of boosting pension coverage. Having to opt out, rather than opt in, is an efficient way of getting people to save more.
But the US experience of auto-enrolment suggests it is not a panacea. For one thing, while the assets seem relatively stable (fewer than 10 per cent of automatically enrolled employees opt out), automatic enrolment is only one step in preparing them for retirement. For another, millions of minuscule individual accounts require hefty systems and support from service providers. Without promise of significant asset growth, such low-balance accounts put pressure on plan providers’ profit margins, and make servicing retirement plans an unattractive proposition.
“Auto-enrolment alone isn’t really enough for anybody,” says David Bauer, a partner with consultancy Casey Quirk.
Auto-enrolment was given a boost by the Pension Protection Act (PPA) of 2006. The US law was adopted with the hope it would stoke greater participation in defined contribution plans among workers at a time when the burden of saving for retirement has shifted from employers to individuals. Defined benefit schemes in the US cover only about 10 per cent of private sector workers (compared with 62 per cent in 1980), personal saving rates hover near zero, and government-funded social security faces a shaky future.
At the same time, the average savings in defined contribution accounts are abysmal. In 2006, the average balance for workers in their 50s with between 20 and 30 years of contributions was $192,000 (£108,000, €136,000), according to the Employee Benefit Research Institute. The median total savings for all 401(k) participants was $66,550 – savings meant to keep retirees afloat for 25 years or more.
The PPA allows employers to automatically enrol workers in their plans, and default them into one of three classes of investment options. Two years since the US law passed, only 34 per cent of large plan sponsors are automatically enrolling workers, and of those 83 per cent only apply auto-enrol features to newly hired workers, according to data from Hewitt Associates.
“I don’t think it’s been as pervasive as people hoped,” says Jude Metcalfe, senior vice-president of retirement services at Boston Financial Data Services, which provides record-keeping services for about 5m workers representing 245,000 defined contribution plans.
One reason may be the cost to employers and service providers. For a large employer with otherwise low participation in their defined contribution plan, the requirement to match employee contributions, if only a 3 per cent match, could mean millions of dollars a year.
For plan record-keepers the task of providing paper statements, educational programmes and other administrative services for many low balance accounts puts pressure on profit margins.
Another pitfall is the average 3 per cent contribution rate at which employers have enrolled employees. At that level, it is doubtful workers will have anywhere near what they need to fund their retirement. “A lot of people take that as a recommendation,” says Alison Salka, a director with MassMutual Retirement Services.
But that rate is far less than the 8.5 per cent that participants who elect to join a plan typically kick in, according to Hewitt. MassMutual research has shown that it has little effect on the proportion of workers who opt out of their plans whether deferral rates take 3 per cent or 6 per cent of an employee’s salary,.
Regardless of the initial rate, auto-escalation must also be part of successful plan design if workers are to accrue meaningful nest eggs. Best practice includes increasing deferrals 1 per cent annually plan-wide each year. While 14 per cent of employees will opt-out of auto-escalation, only 1 per cent of those offered the feature voluntarily take advantage of it, MassMutual research shows.
Investment options serve as another critical plan design piece, says Casey Quirk’s Mr Bauer. Investors confronted with 20 or more options typically choose nothing at all.
Going into the default fund in the past typically meant saving into a stable value fund, with low growth prospects. Under the new rules brought in by the PPA, stable value funds are off the default menu. “Bigger assets are good for the participant, good for the sponsor and good for the provider,” says Mr Bauer. “Auto-enrolment is a nice stepping stone, but we are still in early days.”
Hannah Glover is a reporter with Ignites, a Financial Times publication
