A new study released jointly by EBRI and DCIIA finds that auto-enrollment and auto-contribution escalation in 401(k) plans—depending on how they’re implemented and used—can result in a big improvement in retirement savings, especially for low-income workers.
NEW SIMULATION MODEL: This Issue Brief expands upon earlier work by EBRI to provide the first results of a new simulation model that estimates the impact of changing 401(k) plan design variables and assumptions on retirement income adequacy. Previous research has demonstrated the large potential impact of auto-enrollment (AE) on retirement income adequacy. Until recently however, there was extremely limited evidence on the impact of automatic contribution escalation. This study is part of a larger joint project between Employee Benefit Research Institute (EBRI) and the Defined Contribution Institutional Investment Association (DCIIA).
METHODOLOGY: The definition of “success” for this analysis is a situation that produces a combined real replacement rate from Social Security and 401(k) projected balances of at least 80 percent. The analysis is limited to younger employees (with 31–40 years of 401(k) eligibility) and provides separate results for employees in the highest- and lowest-income quartiles. Using this definition of success, the model is used to determine how success changes with:
• The maximum level of employee contributions allowed by the plan sponsor (6, 9, 12 and 15 percent of compensation).
• The annual increase in contributions (1 vs. 2 percent of compensation). • Whether employees are assumed to opt out of the automatic escalation.
• Whether employees are assumed to remember/retain their previous level of contributions when they change jobs vs. reverting back to the plan’s initial default.
IMPORTANCE OF 401(K) PLAN DESIGN FACTORS: The results in this paper demonstrate the profound influence of plan design variables, as well as assumptions of employee behavior in auto-enrollment 401(k) plans. Even with a relatively simple definition of “success,” large differences in success rates can be seen, depending on which plan design factors and employee behavior assumptions are used:
• The probability of success for the lowest-income quartile increases from the baseline probability of 45.7 percent to 79.2 percent when all four factors are applied.
• The impact on the highest-income quartile is even more impressive, with an increase in the probability of success from 27.0 percent to 64.0 percent.
WORKER CONTRIBUTIONS A KEY FACTOR: When viewed in isolation, it is clear that the impact of increasing the limit on employee contributions is much greater than any of the other three factors. However, the importance of including one or more additional factors, along with the increase in the limit on employee contributions, can more than double the impact of increasing the limit by itself.
EBRI Issue Brief
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Figure 3 Whil of the automa VanD e succ erhei ess rates of 79. (20tic escalatio 10) also mon 2 de , perce and led the partici nt for follo p eat wi me in ng: ployees i pl ans that n the lo lim west-inco it the auto mmatic contributions e quartile as shown in to 6 perc Figure 3 are certai ent of compensation nly Jack VanDerhei is research director of the Employee Benefit Research Institute (EBRI). Lori Lucas is the Defined 15 Figure 5 Figure 1 References Introduction 6 Success Rates of Achieving an 80 Percent Real Replacement Rate From Social Defined as an employee with career-average earnings at about 100 percent of the average wage index (AWI). noteworthy, and increase t thhose fami e contribut liar io with ns by 1 401(k percent per year ) plans will undou (thbetedly “all-pessimis questiont the ic” assumpt likelihooio dn of scenario escalati )ng these . employees to a Contribution Practice Leader at Callan Associates and chair of the Defined Contribution Institutional Investment CDFs* of the Two AuExtreme Combinations to-Enrollment (With 2009 of Design Formulae)Variables and Security and 401(k) Accumulations Combined Under Various Assumptions Previous Holden ? Simulate , Sar rese aa h, and d rch balhas demo ances that Jack VanDerhei nstrated would be t. “Can 401(k) Acc h ge e lanerat rge potent ed under ial i umula m the pre-20 pacttion of auto s G 05e -enrol form nerate Significant Incom ulae. lment (AE) on retireme e for Future nt income a Retirees?” dequacy. 15 percent contribution rate. Therefor vs. Voluntar e, t y w Eo alt nrollmen ernative limit t (With 2005 s of em Fo ployee contribut rmulae): 50th P ion rat ercenes tiles (9 and 12 percent) are Employee Response Assumptions for Employees Currently Ages 25–29 and Association (DCIIA) Research & Surveys Committee. This Issue Brief was written with assistance from the Lowest Quartile 7 2009 OASDI Trustees Report, Table VI.F10 (assuming future elig —Annual Sche ibility duled Benefit Amounts for Retired Workers. is a function of current eligibility) Until rec In contrast, t EBRI Issue Br ently hhowever, e highest ief, no. 251 (Employee Bene ther rates are experien e was extremely limit ced by fit Researc ed evi employ denc ees e h Institute, N w on the impact of auto ho do “remembe ovember 200 r” the mati ir pr 2). c contri evio us co bution escalatio ntribution rat nes when . 6.0% 6.0% 6.0% 6.0% 9.0% 9.0% 9.0% 9.0% Assumed 31–40 Years of Eligibility, High- vs. Low-salary Quartiles graphed in Figure 6. Moving the maximum employee contribution rate down to 12 percent lowers the success rate for Institute’s research and editorial staffs. Any views expressed in this report are those of the authors and should not Don't Don't Don't Don't ? The portion of balances attributable to employer contributions (to test the assertion that increased probability of November 2010 • No. 349 100% VanD they cha erhei nge (20 jo10) provides bs, do not o stochastic simu pt-out of the automatic escala lations of the ition, and part mpact of AE aicipate in pla nd automatic ns that a contributio llow the automatic n escalation for 401(k) Remember Remember Remember Remember Remember Remember Remember Remember the lowest-income quartile em 7ployees to only 73.5 percent, and moving it even lower to 9 percent still results in a 8 be ascribed to the officers, trustees, or other sponsors of EBRI, EBRI-ERF, or their staffs. Neither EBRI nor EBRI- For example, career Auto-Escalation -average earnings at about 45 percent of the national average wage index (AWI) are projected to have ________. “The Influence participation under AE w of Autom ill result in atic less generous em Enrollment, Catch-Up ployer contri , and butio IRA Contributions ns). on 401(k) Accumulations at partici contributio pants of large spo ns to increase to nsors. This 15 percent o Issue f compensation Brief expands and upoincrease t n that moh del e contr to provi ibutdio en the f s by 2 irst result percent per year s of a new (the “all- 90% Delta Don't Opt Out Opt Out Don't Opt Out Opt Out Don't Opt Out Opt Out Don't Opt Out Opt Out success rate of 64.2 percent (equivalent to the success rate for the highest-income quartile with a maximum ERF lobbies or takes positions on specific policy proposals. EBRI invites comment on this research. real replacement rates of 49.0 percent, while career 1.0% 46.5% 45.7% 48.5% -average earnings 47.5% at about 160 perc 59.2% 56.4% ent of the AWI 63.2% are projected to have 59.4% Retirement.” EBRI Issue Brief, no. 283 (Employee Benefit Research Institute, July 2005. simulation mo optimistic” assump del that tion scenario) estimates of t . he impact of changing 401(k) plan design variables and assumptions on retirement 2.0% 47.5% 47.0% 48.9% 48.3% 62.1% 60.6% 64.2% 62.5% contribution rate of 15 percent). 6 80% ? Sensitivity analysis on: real replacement rates of 30.1 percent. Lowest Quartile income adequacy. This study is part of a larger joint project between Employee Benefit Research Institute (EBRI) and The original results of this research were presented at the DCIIA’s Public Policy Forum on May 11, 2010. 12.0% 12.0% 12.0% 12.0% 15.0% 15.0% 15.0% 15.0% VanDerhei. “Measuring Retirement Income Adequacy, Part One: Traditional Replacement Ratios and Results for 70% Similar information is provided Don't for the lo Don't west-income quartile employees. As ex Don't pecte Don't d, the success rates are somewhat Voluntary Enrollment The Impact of Auto-enrollment and Automatic Contribution Whil the D e th efined C e high oe ntributio r success rat n Institutional I es for employ nvestment Association ees in the lowest-income (DCIIA qu ) artile that wi (rel ll iative nclude develo to those in pmen thet of a highest-i plan-s nco pe m cific e 9 o Alternative (lower) rate-of-return assumptions. Remember 5 Remember Remember Remember Remember Remember Remember Remember 401(k) projected balances include any balances that originated in a 401(k) plan that have been rolled over to an IRA. Workers at Large Companies.” EBRI Notes, no. 9 (Employee Benefit Research Institute, EBRI Issue Brief, no. higher, given the larger Social Sec 60%urity replacement rates for this group, varying from 45.7 percent to 79.2 percent. Auto-Escalation quartil simulation mo e) will cdel ome as no allowing sur additio prise to nal those plan des familiar ign varia with t bleh se man to be a ner naly in zwhich ed. Social Security retirement benefits are Escalation on Retirement Income Adequacy Delta Don't Opt Out Opt Out Don't Opt Out Opt Out Don't Opt Out Automa Opt Out tic Enrollme Don't Opt Out nt Opt Out 273 September 2004): 2 -12. 14 Post-2009 401(k) 10 1.0% 66.7% 61.0% 71.8% 65.1% 70.4% 62.1% 76.6% 66.8% Copyright Inf o ormation: Impact of cas This houts. report is being published jointly by EBRI and DCIIA, and is copyrighted by the computed, the difference betw50% een the two employee groups in the marginal increase in success rates resulting from An annuity purchase price of 18.62 for a male age 65 was used for the conversion of the account balances to a real annuity. 2.0% 70.6% 4 68.0% 73.5% 70.6% 75.5% 71.4% 79.2% 74.7% "Accumulations" as a The relative importance of each of the factors described above is presented in Figure 4. Each bar portrays the By Jack VanDerhei, Employee Benefit Research Institute, and Lori Lucas, Callan Associates Employee Benefit Research Institute (EBRI). It may be uHighest Quartile sed without permission but citation of the source is increasing the maximum employee contribution rate may not be as obvious. Given the relatively low success rates for Multiple of Final Earnings Similar analysis for females will be added in a future publication. ________. “ EBRI Employe Retirem e Benefit ent In Reseacome Adequ rch Institute Issue B acy After PPA rief (ISSN 0887 and FAS 158: ?137X) is publish Part One—Pl ed monthly by thean Spon Employeesor Ben se ’ fit Reac Resear tion chs.” InstiIss tute, ue 40% Background 6.0% 6.0% 6.0% 6.0% 9.0% 9.0% 9.0% 9.0% increased probability of success relative to the all-pessimistic assumption scenario. The first four sets of bars (one for o Limited to plan sponsors that froze or closed the DB plan to new employees between 2005 and 1100 13th St. NW, Suite 878, Washington, DC, 20005-4051, at $300 per year or is included as part of a membership subscription. Periodi- required. Don't Don't Don't Don't both groups of employees with a 6 percent maximum employee contribution rate (48.9 percent for the lowest-income 12 Brief, no. 307 (Employee Benefit Research Institute, July 2007). 3 Since the lo cal 19 wes s po 96, tsta -p E g ai e B d ra RI a quartil te pai nd t d ie an nh W eRemember I ad sn hvestment Co one for ingto30% n, D Remember th C, an e hi d a mpany I ghes dditi Remember ot- nal pai n mail stitut d in qu g o Remember e (I artiles ffice CI) have s. P ) s Ohow t STM c AS o Remember he mar llaborate TER: Send ginal d Remember ad in i drm the coll espact of s chaRemember nection ges eac to:h EBRI Iss factor of dat Remember a on ue Br alone. ief, 11 00 It is 11 2009, inclusive. Employees were assumed to either (1) not opt out or (2) opt out at rates described in VanDerhei (September 2007). quartile and 28.9 percent for the highest-income quartile), an increase of 3 percent of compensation in the maximum Auto-Escalation 1 13th St. NW, Suite 878, Washington, DC, 20005-4051. Copyright 2010 by Employee Benefit Research Institute. All rights reserved. No. 34. partici clear th pants i at whe n 401(k n considere ) plans. d in This isolation, database thre e o inclu f th des demo e four factors investi graphic inform gated have ation, as on well ly a mi as administrati nimal impact. T ve data he on in an crease nual Delta Don't Opt Out Opt Out* Don't Opt Out Opt Out Don't Opt Out Opt Out Don't Opt Out Opt Out Recommended Citation: Jack VanDerhei and Lori Lucas, “The Impact of Auto-enrollment and Automatic 20% ________. “The Expected Impact of Automatic Escalation of 401(k) Contributions on Retirement Income.” EBRI employee contribution 1.0% rate27.4% will result in a signific 27.0% 28.6% ant incr28.2% ease in success 35.9% rates for bot 34.1%h groups 39.4% (15.3 p 37.1% ercentage points NEW SIMULATION MODEL: This Issue Brief expands upon earlier work by EBRI to provide the first results of a new 12 2 on the contributio limitn in s, plan employee o bala Impact o nces, cont asset allocation, an fributions whether em is mployee "rem uch more d loa subs nembers" s. tantial This in level o (eith format efr co 14. ion is ntri 1 or butions dissemin 16.4 perce from ated vi ntage previous 4 a jointl point incr y pu 01(blishe k) pla ease d a n. in n nual 2.0% 27.9% 27.6% 28.9% 28.6% 38.6% 37.8% 41.0% 39.9% For example, t Contributionh E e 0.4 percent scalation ona R ge point incr etirement Inc ease for the hig ome Adequac hest-paid quart y,” EBRI Issue ile for the Brief, no impact of n . 349, and ot optin DCIIAg R ou esearch t is derived from Report for the lo Notes, west-income no. 9 (Employee Benefit Researc quartile an 10% d 12.1 percentage point h Institute, S s fo er th ptember 20 e highest-income 07): 2–8. quartile). The next 3 percent Highest Quartile 2 simulation mo del that estimates the impact of changing 401(k) plan design variables and assumptions on retirement proba update bs on ility) “4 ; h01(k owever, t ) Plan his f Asset Allocatio actor by itself n, still accounts f Account Balano ces and Loan r less than h a Activity.” lf of the im As of pact of a Dece dmbe ding al r 31 l four , 20 factors 08, the at once 12.0% 12.0% 12.0% 12.0% 15.0% 15.0% 15.0% 15.0% taking the diffe (November rence of the 27.4 percent in the upper right 2010). hand corner of Figure 3 and the 27.0 percent from the all- The Employee Benefit Research Institute (EBRI) was founded in 1978. Its mission is to increase in contributions (from 9 percent to 12 percent) still provides a 12.0 percentage point increase in success rates Don't Don't Don't Don't income adequacy. Previous research has demonstrated the large potential impact of auto-enrollment (AE) on retirement 0% 1 (bottom ro database incl w o ud f bars). ed indivi dual information on: 100 105 110 115 120 125 130 135 140 145 pessimistic assumption scenario for the highest-paid quartile. ________. “The ImpactRemember of Automatic Enrollment in 4 Remember Remember Remember 01(k) Plans on Future Retir Remember Remember ement Accum Remember ulation Remembers: A New Simulation Results contribute to 15% 20% 25% 30% , to encourag 35% 40% 45% 50%e, an 55% 60% d to enhanc 65% 70% 75% 80% e the developmen 85% 90% 95% t of sound employee benefit for the highest-income quartile (compared with only a 9.3 percentage point increase% for t % h %e lowest % % %-income % % % quarti % le). income adequacy. Until recently , however, there was extremely limited evidence on the impact of automatic contribution Auto-Escalation Who we are Report availability: This report is available on the Internet at www.ebri.org and at www.dciia.org programs and sound public policy through objective research and education. EBRI is the only Lowest–income quartile, all pessimistic 0% 0% 0% 0% 0% 2% 6% 9% 13% 20% 26% 35% 44% 54% 64% 71% 77% 80% 83% 86% 88% 90% 92% 93% 94% 95% 95% Simulation Study Based on Plan Design Modifications of Large Plan Sponsors.” EBRI Issue Brief, no. 341 Delta Don't Opt Out Opt Out* Don't Opt Out Opt Out Don't Opt Out Opt Out Don't Opt Out Opt Out The basic objective of this report is an analysis of how the probability of “success” changes with different 401(k) plan The final increase (from 12 percent to 15 percent of compensation) still provides an 11.0 percentage point increase for 13 escalation. This study is part of a larger joint project between Employee Benefit Research Institute (EBRI) and the Although ? 24.0 the millio 80 Hin ghes 1.0% perc 401(k t-incent co ome quart ) plan il43.7% e, mbine al par l pessim td r iicipants, i sprivat ticeal r 38.8% e, nonprof eplacem n 50.1% ient rat t, nonpar es 43.6% tisan provi , Washington, DC-b ded in Fi 50.0% gure 3ased organi may 41.1% provide zati58.6% on com a usefm ul ran itted exclusivel 47.1% ge of success y to 0% 1% 2% 4% 7% 12% 19% 28% 37% 46% 55% 63% 69% 73% 76% 80% 83% 85% 87% 89% 90% 91% 92% 93% 94% 94% 95% 100 percent minus 17 percent. 0 (Employee Benefit Researc 2.0% 49.1% h, April 2010). 46.9% 53.0% 50.4% 57.5% 52.9% 64.0% 58.4% design variables and assum Lowest-income quartile,p altions. l optimistic While 0% 0% the 0% 0% defi 0%nition 2% 5% of 6% success usi 7% 9% 11% 14%n 17% g t 21% his simulat 25% 31% 37% 43% ion model c 50% 57% 64% 69% an 73% be 77% quite 78% 81% com 83% plex, the highest-income quartile but, given the relatively large success rates for the lowest-income quartile at 12 percent public policy research and education on economic security and employee benefit issues. Source: EBRI/ERF Retirement Security Projection Model, versions 100810a1100810a16. Defi rates in ned Contri genera bution l, plan spo Institut nsors undou ional I 25 n–vestment Associatio 29 btedly wil 30–34 l have35 pl –an-s n (DCIIA 39 pec 40 ific – ). 44 (or even 45–49 cohort 50 - –or partic 54 55 ipant –59 -specific 60–64) targets as 4 Highest-income quartile, all optimistic 0% 1% 2% 2% 3% 4% 6% 8% 10% 14% 19% 24% 30% 36% 43% 50% 55% 60% 64% 68% 71% 73% 76% 78% 80% 82% 84% * See VanDerhei (2007) for distribution of optout rates from the Retirement Confidence Survey. 14 EBRI’s membership includes a cross-section of pension funds; businesses; trade associations; this analysis starts out w ? 54,765 employer-sponsore ith a very simp d 401(k) le plans, definitholdin ion for th g is initial application: namely, a 401(k) accumulation large (73.5 percent), this results in an increase of only 5.7 percentage points. The primary insurance amount (PIA) is the benefit a person Cur would rent Age receive if he/she elects to begin receiving part of their overall strategic planning for retirement plan design. Therefore, Figure 5 provides a series of cumulative VanDerhei and Copeland. “Can America Afford Tomorrow's Combi Retire nedReal es: Re ReplacementRate sults From the EBRI-ERF Retirement Table of Contents labor unions; health care providers and insurers; government organizations; and service firms. enough th METHODOat, LOG when Y: The combine definition of d with t “succ he wor ess” for ker-spec this a ificn be alysis is nefits projecte a situatio d u n that nder pro Socia duces a com l Security, w bined rea ill provide l re a tota placement l real retirement benefits at his/her normal retirement age. For an individual who first becomes eligible for old-age insurance distribution functions (CDFs) that will allow the plan sponsor to choose from a large number of potential thresholds for Security Proj Source: e EBRI/ERF ction Model.” Retirement Sec EBRI Issue Br urity Projection Model, v ief, no. 263 (Employee Benefit Resear ersions 100810a1–100810a16. ch Institute, November 2003). Introductio These results are not ? $1.092 n trillio .................................................................................................................. n in assets. suggesting that plan sponsors should attempt to put different constraints on ............................ 3 401(k) participants ® replac rate from ement Soci r Source: EBRI/ERF ate of al Sec 8 urity a 0 perc Retirem nd 4 ent. ent 01 Security Projection This (k) proj is in e the cted Model, typical bala versions 100205a1 and nces ra nge of at of least replace 100205b1. 80 m perce See ent rates text n for t. T explanations h su e a ggeste n of alysis is limit models d and by m assum any fi ptions. ed to nancia younger l * Cumulative distribution functions. benefits or disability insurance benefits in 2010, his/her PIA will be the sum of: measuring success. EBRI’s work advances knowledge and understanding of employee benefits and their 5 based on their relative income levels (even if such practice were legal). However, it is clear that given a specific plan- consultants. Backgroun employeesd (wi ............................................................................................................................... th 31–40 years of 401(k) eligibility) and provides separate results for employees in th ................ 3 e highest- and importance to the nation’s economy among policymakers, the news media, and the public. It ________. “The EBRI Retirement Readiness Rating:™ Retirement Income Preparation and Future Prospects.” wide success rate target, sponsors can use different communication strategies for their employees: i.e., those with (a) 90 percent of the first $76 does this b 1 of his/her av y conducting erage indexed and publishing policy re monthly earnings, plus search, analysis, and special reports on A CDF describes the lowest-income quart pro iles. b abi lity that a value (in this case the simulated multiple of final earnings at retirement age) will Previous Simulation Results What we do Previous Sim EBRI Issue Br ulation Results ief, no. 344 (Employee Benefit Rese ................................................................................................... arch Institute (July 2010). ..................... 3 6 The percentage of earnings replaced by employSo ee benef cial Sie ts issues; holding educational br curity for scaled medium-earni iefings for EBRI memb ngs workers retirin ers, congressional and g at age 65 in 2050 lower incomes (and hence higher likely replacement rates from Social Security) can be shown how escalating their be a value less than x. For example, Figure 5 focuses on the two extreme combinations of plan design variables and VanDerhei and Copeland (2008) simulated the impact of 401(k) sponsors changing from voluntary to automatic 7 New Simulation Results .............................................................................................................................. 5 federal agency staff, and the news media; and sponsoring public opinion surveys on employee (b) 32 percent of his/her average indexed monthly earnings over $761 and through $4,586, plus is Using this projected to definition o be 36.3 f succ perce ess, the model nt. However, t ish used to e Primary Ins determine urance Amoun how success chan t (PIA) formul ges with: a used to determine monthly contributions to a level that may be more affordable, given their disposable income, would still result in success rates ________. “The Impact of employee behavior assumptions mentione PPA on Retireme d abnt Saving ove. The stwo bottom for 401(k) Participants.” lines show the r EBRI Issu esults for t e Brief, he high no. 318 est- and lowest- enrollment; however, given the close benefit issues. proximity to t EBRI’s Ed he passa ucation and Re ge of the Pension search F Protection Act o und (EBRI-ERF) performs f 2006 (PPA) ther the charite was able, Summary .................................................................................................................................................. 8 Social Security retirement benefits skews the Social Security portion of the replacement rates heavily in favor of the equivalent to employees with higher income contributing at a higher level. (Employee Benefit Research, June 2008). salary quartiles under the most optimistic educationa combinations l, and scientif ic func (i.e., employ tions of the Instit ees who do ute. EBRI “remember -ERF is a tax-ex ” their previo empt organizatio us contribution n ? The maximum level of employee contributions allowed by the plan sponsor (6, 9, 12, and 15 percent of no way of knowing what the AE plan design parameters would look like. As a result, the PPA safe harbor provision was 8 (c) 15 percent of his/her average indexed monthly earnings over $4,586. lower paid. Therefore, a new component was added to the model to simulate each worker’s Average Indexed Monthly supported by contributions and grants. References .............................................................................................................................................. 10 rates when they change jobs, do not opt-out of the automatic escalation, and participate in plans that allow the Figure 2 compensation). Figure 6 used as a prototype in the 2008 study. Moreover, there was no way of knowing the plan design parameters of 401(k) Earnings a VanDerhei, nd t Jah ck, Sar e resua ltin h H g PI old A and replace en, and L ouim s Alon ent rate, so. “40 assuming ther 1(k) Plan Ae a sset Allocation re no statutor , y chan Account Bal ges to t ances, and L he computatio oan n of Employees Currently Ages 25–29: Figure 4 automatic contributions Success to increase to Rates of Ac 15 percent hie of co ving m a pCombined ensation and increase th 80% Real Replacement e contributions by 2 percent per Endnotes Summary See www.ssa.gov/OACT/C ...................................................................................................................... OLA/piaformula.html for more information. .......................... 10 sponsors that would subsequently choose to adopt AE. As determined in a joint EBRI/Mercer study (VanDerhei, July EBRI Issue Briefs are periodicals providing expert evaluations of employee benefit issues and Social Activity in 2008.” Security retiremeEBRI I nt benefits by 2050. ssue Brief, no. 335 (Employee Benefit Research Institute, October 2009). Median 401(k) Accumulation Multiples for Auto-Enrollment With 2009 Plan Formulae Increase in Probability of Success* From Modifying Plan Design ? The annual increase in cont Rate ributions From Social Security and 401(k) Accum (1 vs. 2 percent of compensation). ulations, year), while the two top lines provide the results for the highest- and lowest-salary quartiles under the most pessimistic 2007), there is a high correlation between those employers that choose to adopt AE for their 401(k) plans and those The results in this paper demonstrate the profound influence of plan design variables, as well as assumptions of trends, as well as critical analyses of employee benefit policies and proposals. EBRI Notes is a Our 15 as a Function of Salary Quartile and Number of Years Eligible for a 401(k) Plan Features of Automatic Escalation and Employee Behavior as a Function of Maximum Employee Contributions All reports are available at www.ebri.org/publications/ib/ or www.ebri.org/publications/notes/ combinations (i.e., employees who do not “remember” their previous contribution rates when they change jobs, have a monthly periodical providing current information on a variety of employee benefit topics. employee that froze/c beh losed t avior in heir auto-e definenrollment d benefit 4 (D 0B) pe 1(k) pla nsion ns. Even plans. Fo witrtu h a n relat ately, ively simpl EBRI was abl e dee finition to circ of umvent “success,” lar these limitati ge ons in (Total balances, baseline assumptions) The definition of “success” for this analysis is a situation that produces a combined real replacement rate from Social ? Whether employees are assumed to opt out of the automatic escalation. EBRI’s Pension Inv Lowest-paid Q estme uartile nt Report Highes provides detailed fin t-paid Quartile ancial information on the universe of 90% stochastic opt-out of the automatic escalation, and participate in plans that limit the automatic contributions to 6 per- Endnotes publications 9 10 late 2009 with data on actual retirement plan sponsor activity from Benefit SpecSelect™ (a trademark of Hewitt differences in success rates can be seen, depending on which plan design factors and employee behavior assumptions Security and 401(k) projected balances of at least 80 percent. The analysis is limited to younger employees (with Figures 9 defined benefit, defined contribution, and 401(k) plans. EBRI Fundamentals of Employee Percentage Point Increase in Success Relative to All-pessimistic Scenario cent of compensation and increase the contributions by 1 percent per year). Associates are used: LLC). 80% ? Whether employees are assumed to rem Benefit Programs ember/r offers a straightforward, b etain their previous asic exp level of lan contri ation of bu emplo tions wh yee b en t enef hiey chan t programs in ge jobs 31–40 years of 401(k) eligibility) and provides separate results for employees in the highest- and lowest-income Income Quartile Figure 1, Auto-Enrollment (With 2009 Formul 0.8 ae) vs. Voluntary Enrollment (With 2005 Formulae): 1 No Opt Out 0.4 The EBRI/ICI Participant-Directed Retire the priv ment Plan Data ate and public s Collection Project ectors. The EBRI Data (the EB book on Emplo RI/ICI 401(k) database yee Benefits ) is the largest, is a statistical 8 vs. reverting back to the plan’s initial defa Lowes ult. t quartiles. 50th Percentiles ............................................................................................................................................. 4 70% If one was interested in determining the range in success rates for a combined real replacement rate greater than 1.8 VanDerhei (2010) simulated the dif referen ference betw ce work oeen n emplo AE y aee ben nd vol euntary fit progrenrollment ams and work force-related issues. by comparing large 401(k) spon www.ebri.org sors ? The probability of success for the lowest-income quartile increases from the baseline probability of 45.7 percent to Remembering Level From Last Job most representative repository of information about individu 2 al 401(k) plan participant accounts 1.2 Figure 2, Employee 75 percent, for example, s Cu lookin rrently 7g at Ages 25 the gri –29: Media d at the bottom o n 401(k) Accu f Figure mulation Mult 5 shows that 17 per iples for Auto cent of the lo -Enroll west-income ment 60% with actual 79.2 percent plan des when ign par all fou ameters r factors are a . Figure 1 shows only p pplied. ost-2009 accumulations (and rollovers) and, as expected, 3 I (www.ebri.org/pdf/bri MPORTANCE OF 401(K) PL efspdf/EBRI_IB_10-2009_No335_K-Up AN DESIGN FACTORS: The results in date.pdf). this paper demonstrate the profound influence of plan Using this definition of success, the model is used to 1.3 determine how success changes with: Increase Auto-escalation With 2009 Plan Formulae as a Function of Salary Quartile and Number of Years Eligible for a 0.6 quartile under the most optimistic co Contact EBRI mbination of Publications, (2 assumptions w 02) 659-0670; ould have a co fax publication mbined real r orders to eplacem (20 ent rat 2) 775-6312. e of less than the simulated balances (as a multiple of final ear Highes nin t gs) would be minimal for older age cohorts. However, for those design variables, as well as assumptions of employee behavior in auto-enrollment 401(k) plans. Even with a relatively 50% 6 13 401(k) Plan ................................................................................................................... Subscriptions to EBRI Issue Briefs are included 16.4 as part of EBRI membership, or as part of ................................. 4 a 2 Increase Limit on Employee Contributions or ? equal The to impact 75 pe on rcent. the hi Ther ghest-i efore, ap ncome quartile proximately 8 is even 3 perce more nt im of t pressive, wit hese individuals h an incr woul ease i d be successful n the probability of success in achieving that See Va ? Orders/ The nDerhei, maximum Holden and Alonso (2009) level of employee contri for the most recent report from year-end 2008 butions allowed by the plan 14.1 sponsor (6, 9, 12 data The and 15 percen update for year-end t of 2009 with a major portion of their careers remaining, the differences in additional accumulations due to auto-enrollment simple definition of “success,” large differences in success rates can be seen, depending on which plan design factors Post-2009 401(k) $199 annual subscription to EBRI Notes and EBRI Issue Briefs. Individual copies are available 40% Figure 3, Succe target. from 27.0 per ss cRate ent to s of Achieving an 64.0 percent. 80 Percent Real Replacement Rate From Social Security and "Accumulations" as a 24.7 data is currently scheduled for November 201 5 0. prove to compensation be quite si). gnif icant: When workers currently ages 25–29 are compared, the median 401(k) balances increase Increase Limit and No O with prepa pt Out yment for $25 each (for printed copies). Change of Address: EBRI, 1100 13th St. and employee behavior assumptions are used: 23 Subscriptions Multiple of Final Earnings 401(k) Accumulations Combined Under Various Assumptions ..................................................................... 7 NW, Suite 878, Washington, DC, 20005-4051, (202) 659-0670; fax number, (202) 775-6312; from approximately 1.5 tim 30%es final earnings under voluntary enrollment to more than 6.0 times final earnings in the 21.1 3 Increase Limit and Remember Level 4 4 Whe Figure n vi 5 ewe demo d in isolation, nstrates very clearly th it is clear t e-m h at th aat th il: e import firstname.lastname@example.org e impact of ance inof creasing the plan rg desiMe gnmbe li param mit on rship Information: eters a employ 20.1 nee contr d/or assumpt Inquiries reg ibutioin ons wit s is much gr arding EBRI h respeater ect to It is important to note that this models all U.S. workers. As a result, the balances will be significantly smaller than simulation ? The annual increase in contributions (1 vs. 2 percent of compensation). Figure 4, Increase in Probability of Succe ? The probability of success for the lowess F st-income rom Mquartil odifying Plan Design Features e increases from the baseliof Autom ne probability o atic Escalation f 45.7 percent to auto-enrollment scenario. 20% membership and/or contributions to EBRI-ERF should be directed to EBRI President/ASEC 25.7 than a employee behavior depends ny of the other three factors. However, the impor on what target the plan sponso tance r chooses. At of including on very lo e or m w multi ore additio ples on f f al inal ea factors, alon rnings, t g hwith e models of those current 401( Increase Limit k) participants and Auto-escalation (Holden and VanDerhei, 2002) or those eligible for participation (Holden and and Employee Behavior ................................................................................................................................ 7 79.2 percent when all four factors are applied. 25.9 3 Chairman Dallas Salisbury at the above address, (202) 659-0670; 11 e-mail: email@example.com 3 ? Whether employees are assumed to opt out of the automatic escalation. the i spread between success rat ncrease in the limit on e es for o mployee ptimist contr ic ibutions, c vs. pessimis an more tic scenarios than dois quit uble the e lo im w.pa Fo ct of r exam increasin ple, at g th a combi e limit ned real by itself. VanDerhei, 2005). Increase Limit and No O 10% pt Out and Remember The 6.0 multiple in Figure 1 might appear to be too small to reach conventional retirement income targets. 30.9 Therefore, Figure 5, CDFs of the Two Extreme Combinations of Design Variables and Employee Response Assumptions 31.6 Level replacement rate of only 45 percent, the difference in success rates for the highest-income quartile is 13 percentage 2 ? Editorial Bo The impact ard: on Dallas L the hi . Salisbur ghest-i y,n publisher come quartile ; Stephen Blakely is even , editor more . Any im views pressive, with an increase in expressed in this publication and th the p ose o rob f th ability of success e authors should Figure 2 recasts the AE results from Figure 1 for just the youngest cohort and provides further breakouts by the for Employee Increase Limit s Cu and No O rrently Ages 2 pt Out and Auto- 5–29 and Assumed 31–40 Years of Eligibility, High- vs. Low-salary 29.8 4 0% ? Whether employees are assumed to remember/retain their previous level of contributions when they change jobs This suggests that additional analysis of the influence of plan design variables on optimizing employee results is not be ascribed to the officers, trustees, members, or other sponsors of the Employee Benefit Research Institute, the EBRI Education and See VanDerhei and Copeland (2003) for a detailed explanation of the EBRI Retirement Security Projection Model.™ When all escalation 6% 9% 12% 30.5 15% points, compared with only 1 percentage point for the lowest-income quartile. When the combined real replacement from 27.0 percent to 64.0 percent. number of Quartiles ..................................................................................................................... years eligible for participation in a 401(k) plan as well as the relative income level. For t ................................... 9 hose workers Research Fund, or their staffs. Nothing herein is to be construed as an attempt to aid or hinder the adoption of any pending legislation, regulation, 1 vs. reverting back to the Lowest, Optimistic plan’s initial default. warranted. The n Incre eas xte Limit step and in this Auto-es proj calation 48.9% ect and will include development 64.2% of a plan-spe 73.5% cific simulation m79.2% odel that will allow 29 the elements of the accumulation model (e.g., defined benefit, Social Security, net housing equity) are included, the stochastic rate target increases to 80 percent, the spread between the all-optimistic and all-pessimistic assumption scenarios assumed to or interpretative be elru igi le, or as ble (whe legal, ther or accounting, not t actuarial, o hey choose to r other such prof partici essional advice. pate) for more than 30 years, the m 31.4 edian multiples range Remember Level Highest, Optimistic 28.9% 41.0% 53.0% 64.0% Figure 6, Success Rates of Achieving a Combined 80% Real Replacement Rate From Social Security and additional plan design variables. WORKER CON decumulation model can project probabilitie TRIBUTIONS A KEY FACTOR: s of retirement income adequacy under When viewed in isolation, it is cleara number of differe that the impact ofnt targets. The earlier increasing the limit become considerable: 33 percentage points for the lowest-income quartile and 37 percentage points for the highest- 33.5 0 from approx imately 7. Lowest, Pes 6– simis 8.5 times tic fina 45.7% l salary, depending o 56.4% n salary level. 61.0% 62.1% All Four Figure 3 401(k) Accumulations, as a Function of demonstrates that the success rates for t Maximum Employee he real 80 percent comb Contributions ................................................ ined replacement rate for the highest-income 9 37 on em results were recently updated ployee contributions is (VanDerh much gre ei an aterd Copeland, 2010). than any of the other three factors. However, the importance of including EBRI Issue Brief is registered in the U.S. Patent and T 1–10 rademark Office.11–20 ISSN: 0887 ?137X/90 0887 21–30 ?137X/90 $ .50+.50 31–40 income quartileHighes . t, Pessimistic 27.0% 34.1% 38.8% 41.1% quartile employees vary from as low as 27.0 percent to a high of 64.0 percent. The lowest rates are experienced by Maximum Employee Contributions one or more a Source: dditio EBRI/ERF nal facto Retirement rs, along wit SecurityProjection h the i Model, ncrease Num versions ber in 100810a1–1 of the Year limit o s Eligible 0081n0a1 to e Par 6m . ployee ticipate in a contr 401(ik) butions, c Plan an more than double 5 employees who do not “remember” their previous contribution rates when they change jobs, have a stochastic opt-out * "Success" is defined as achieving an 80 percent real replacement rate from Social Security and 401(k) accumulations combined as See VanDerhei (September 2004) for a discussion of replacement rates. the impact of increasing the limit by itself. defined in the text. The population simulated consists of workers currently ages 25–29 who will have more than 30 years of simulated Sour Sour ce: cSource: e: EBRI/ERF EBRI/ERF Retir Retirement ement Sec Secu urrityProjection ity Projection Model,®vers Model, versiions on100205a4 100810a1–1008 .Seetextforexplanations 10a16. ofmodelsandassumptions. © 2010, Employee Benefit Research Institute ?Education and Research Fund. All rights reserved. eligibility for participation in a 401(k) plan. Workers are assumed to retire at age 65 and all 401(k) balances are converted into a real annuity at an annuity purchase price of 18.62. ebri.org ebri.org ebri.org ebri.org ebri.org ebri.org ebri.org A monthl ebri.org Issue Brief • November ebri.org Issue Brief • November ebri.org Issue Brief • November Issue Bri Issue Bri Issue Bri Issue Bri Issue Bri Issue Bri Issue Bri y research report f e e e e e e efffffff • November • November • November • November • November • November • November rom th2010 • No. 349 2010 • No. 349 2010 • No. 349 2010 • No. 349 2010 • No. 349 2010 • No. 349 2010 • No. 349 e EBRI Education and Re 2010 • No. 349 2010 • No. 349 2010 • No. 349 search Fund © 2010 Employee Benefit Research Institute 4 7 9 10 11 6 8 3 5 2 Probability