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Automatic 401(k) Enrollment and Its Influence on Savings

Highlights from Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance, by James J. Choi, David Laibson, Brigitte C. Madrian, and Andrew Metrick, Working Paper 8655, National Bureau of Economic Research, December 2001.

In this paper the authors study the impact of plan structure on participant behavior in a large sample of plans which underwent change. They examined the effect on participant behavior of changing many different features of 401(k) plans and discovered one standard common denominator: a large portion of participants inevitably follow the path of least resistance in their 401(k) investing. Because of this, plan sponsors greatly impact the savings and investment choices of participants through plan structure and plan rules. This is especially true in the case of automatic enrollment (AE).

  Most 401(k) plans require that the participant actively elect to participate. However, a growing number of plan sponsors have begun to enroll employees automatically unless they specifically opt out of the plan. (A Hewitt survey reported that 14% of plans had AE in 2001, twice as many as in 1999.) A major reason for adopting AE is to increase the participation of lower salary workers and reduce discrimination testing problems. The Treasury department has issued several rulings supporting the use of the practice for both newly hired and existing employees who are not participants. 

When the path of least resistance is being enrolled automatically, participation rates rise substantially and stay higher. The table below gives the comparative participation rates by job tenure.

Effect of Adding Automatic Enrollment on 401(k) Plan Participation (employee participation rates)

Without automatic enrollment there is a significant increase in participation over time, but the introduction of AE raised participation by more than 30% even after 36 months. The study also found that there was little increase in plan drop-out rates relative to pre-AE levels; the path of least resistance was to stay enrolled. The default rate for automatic enrollment in the three plans studied is much lower than the match rate – two to three percent versus a six percent match. Prior to automatic enrollment only 11-20% of those who participated did so at this lower rate. However, after enrollment became automatic 42-71% of participants opted for the default rate.

The effect on asset allocations is similar. Before AE, participants allocated 10-18% in the conservative option (stable value or money market); after AE the conservative option held 48 to 81% of assets. Unlike participation rates, however, there was a tendency for the allocations to the conservative option to be reduced over time.

The authors conclude that automatic enrollment can be a highly effective tool for promoting retirement savings but that plan  sponsors need to be responsive to the employees’ tendency towards the path of least resistance. If promoting retirement savings is the goal of AE, the program should include higher default rates and a more aggressive investment mix.

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