Most Common 401(k) Savings Default Rate Rises to 6% of Pay

401(k) savings rates hit record levels in 2021, thanks to higher default pay-deferral rates and automatically raising employees’ contributions above the initial default level.

The most common 401(k) default deferral rate for automatically enrolled 401(k) plan participants is now 6 percent of an employee’s pay, according to the recently released 64th Annual Survey from the Plan Sponsor Council of America (PSCA), based on responses from 518 plans.

For the first time, a 6 percent default rate was used by a plurality (33 percent) of surveyed plans, “rather than the 3 percent of pay that has been the norm since 2006,” PSCA reported. A 3 percent default rate was used by 29 percent of plans, the survey found.

Default Rates & Matching Contributions

Selecting a higher default rate has a significantly positive effect on employee savings rates, according to a new research paper, The Impact of Employer Defaults and Match Rates on Retirement Saving, published Dec. 24 by the Social Science Research Network.

The study, by researchers at investment management firm QMA LLC, the American University and retirement plan record keeper Empower Retirement, evaluated the interaction between employer match and default rates on savings outcomes among approximately 157,000 401(k) plan participants.

“Selecting a higher default rate has the largest impact on employee savings rates,” and is more significant than raising matching contributions when it comes to raising savings levels, the researchers found.

“Plans with low default rates that match a high percentage of employee earnings induce higher-income participants to actively move away from the low default savings rate, resulting in a wider savings gap between higher- and lower-income employees,” they reported.

On the other hand, setting default savings rates at a higher percentage of pay drove up employee savings across income levels. “When employees are defaulted in at a higher rate, fewer move away from the default savings rate, resulting in higher and more equal savings rates among employees,” the researchers said.

Escalating Savings Rates

“While raising the default savings level should increase savings rates for new participants, it won’t necessarily help existing participants,” the study noted, and plan sponsors may want to consider automatically enrolling current employees who are not participating in the plan. “Additionally, plan sponsors should also consider including provisions for automatic savings rate increases to further boost participant savings levels,” the researchers advised.

Vanguard Investments similarly suggested in 2020 that “plan sponsors can seek to improve retirement outcomes through automatic enrollment combined with higher initial deferral rates, an automatic increase feature, and a total automatic increase cap of at least 10 percent.”

Due in part to automatically raising contribution rates above the initial default level, Fidelity Investments’ client data shows contributions to workplace retirement accounts hit record levels in 2021, with the average 401(k) contribution rate reaching a record 9.4 percent.

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Written by HR Today

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