EBRI Issue Brief
The Influence of Automatic Enrollment, Catch-Up, and
IRA Contributions on 401(k) Accumulations at Retirement
• Whether many individuals’ 401(k) plan accumulations will provide significant income in retirement has become a public policy concern in recent years. The validity of such a concern cannot be assessed by looking at the 401(k) accumulations of today’s retirees because these individuals have not participated in 401(k) plans throughout their working years.
• The Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) have collaborated to develop the EBRI/ICI 401(k) Accumulation Projection Model. This model examines how 401(k) assets might contribute to retirement income for future retirees based on decisions workers make throughout their careers and finds that the median replacement rate from 401(k) accumulations depends primarily on whether current participants will continue to work for employers sponsoring 401(k) plans. For example, the lowest income quartile participants turning 65 between 2030 and 2039 are simulated to produce a median replacement rate of 25 percent if future coverage is only a random occurrence but 51 percent if each subsequent job is covered by a 401(k) plan. The highest income quartile for that generation has a similar disparity: a 30 percent replacement ratio in the non-continuous coverage situation and 67 percent if coverage is continuous.
• This report builds on the model scenarios presented in Holden and VanDerhei (November 2002). It presents new scenarios that examine the role that 401(k) accumulations might play in retirement by analyzing certain factors that influence outcomes for 401(k) participants, including: plan design, through automatic enrollment; tax policy, through catch-up contributions; and individuals themselves, through saving in IRAs when not offered 401(k) plans.
• A new EBRI/ICI model scenario demonstrates that the effects of automatic enrollment on replacement rates at retirement depend heavily on the default contribution rate and default investment option that the plan sponsor selects. For the lowest income quartile eligible workers turning 65 between 2030 and 2039, the median replacement rates from 401(k) accumulations increase from 23 percent without automatic enrollment to 37 percent for automatic enrollment with defaults of a 3 percent contribution rate and investments in a money market fund. The median replacement rate for this group increases up to 52 percent when the default contribution rate is 6 percent and life-cycle funds are used as the default asset allocation.
• A second new EBRI/ICI model scenario captures the impact of catch-up contributions by assuming that all 401(k) participants age 50 or older who are projected to contribute at the limit in a given year also make the additional catch-up contribution. The model forecasts that individuals in the highest income quartile when they reach age 65 generally would have higher projected replacement rates as a result of taking advantage of catch-up contributions.
• A third new scenario shows the effects of individuals’ taking advantage of IRAs when they are not offered 401(k) plans. This scenario assumes participants contribute to IRAs in an effort to replicate their 401(k) contribution experience, while considering IRA contribution limits. Although projected replacement rates at age 65 increase across all income groups when individuals not offered 401(k) plans contribute to IRAs, the results are most promising for lower income quartiles at retirement. Contribution limits for IRAs generally allow sufficient saving for lower income individuals to replicate their 401(k) experience. Higher income participants find themselves restricted by the lower IRA contribution limits, and thus do not do as well as they would if they always work for employers offering 401(k) plans.