EBRI Issue Brief

The Impact of PPA on Retirement Savings for 401(k) Participants

Jun 27, 2008 24  pages

Summary

• Modeling of auto-enrollment results: This Issue Brief simulates (under several assumptions) the likely impact of 401(k) plan sponsors switching from voluntary enrollment systems to automatic enrollment designs with automatic escalation of contributions for a significant portion of workers (not just current 401(k) participants or those eligible to participate).

• PPA implemented a concept long studied: The concept of auto-enrollment has been studied since the mid-1990s. Support for the concept grew as various studies showed relatively low participation rates among young and low-income workers, and as more defined benefit plan sponsors began freezing their plans for future (and sometimes current) employees. The Pension Protection Act of 2006 (PPA) created incentives for plan sponsors to implement this concept with its 401(k) safe-harbor auto-enrollment and auto-escalation provisions.

• Significant impact, especially for low-income: This analysis indicates that even under the most conservative assumptions for auto-escalation of contributions, switching 401(k) plans to auto-enrollment is likely to have a very significant positive impact in generating additional retirement savings for many workers, especially for low-income workers.

• Range of increases under auto-enrollment: When results are aggregated across all income categories, the increase in the value of 401(k) accumulations at age 65 as a multiple of final earnings for those currently ages 25–29 would be approximately 2.4 to 2.6 times final salary by switching from voluntary enrollment to automatic enrollment.

• Higher-paid unlikely to benefit as much: Although the aggregate results favor automatic enrollment, distributional analysis of the differences between the two systems indicates that the higher paid are not likely to benefit as much from such a change.

• Lowest-paid likely to see significantly higher 401(k) accumulations: The median 401(k) accumulations for the lowest-income quartile of these workers (assuming all 401(k) plans were voluntary enrollment) would only be 0.1 times final earnings at age 65 (this is largely due to the fact that 41 percent of workers—as opposed to participants—were assumed to have zero balances at age 65). However, if all 401(k) plans are assumed to be using the auto-enrollment provisions under PPA, the median 401(k) accumulations for the lowest-income quartile jumps to 2.5 times final earnings under the most conservative assumptions and 4.5 times final earnings under the most beneficial assumptions. Even for the top 25 percent of these workers (when ranked by 401(k) accumulations as a multiple of final earnings), there are large increases: the multiple under a voluntary enrollment scenario is 1.8 times final earnings, whereas auto-enrollment provides multiples ranging from 6.5 to 10.4, depending on auto-escalation of contributions.

• For many, higher assets from auto-enrollment will still not be enough: Comparing income replacement targets generated in previous EBRI work with these simulated 401(k) accumulations shows that, even with the large increases that can be expected for many workers under the safe harbor auto-enrollment plans introduced by PPA, and with current-law Social Security benefits, additional resources will still be needed for some of them.