The concept of automated retirement savings, such as automatic enrollment and automatic escalation in 401(k) plans, has been praised for its potential to significantly boost employees’ nest eggs. However, recent research suggests that the impact of these policies may not be as positive as originally believed.
The Reality of Automated Savings
While policies like auto-enrollment and auto-escalation have been widely adopted by employers since 2006, the long-term impact of these measures may be less effective than previously thought. According to a new paper published by the National Bureau of Economic Research, several factors contribute to reducing the overall effectiveness of automated retirement savings.
One of the key challenges identified in the research is the issue of workers cashing out their 401(k) balances when they leave a job. This “leakage” from 401(k) plans has a significant impact on the long-term savings potential of employees. Approximately 40% of workers cash out their 401(k) plans each year, according to the Employee Benefit Research Institute, resulting in a loss of potential savings.
The Impact of Job Turnover
Job turnover is another critical factor that complicates the effectiveness of auto-enrollment and auto-escalation policies. When workers change jobs, their contribution rates may reset at a lower savings rate if they join a new employer’s 401(k) plan. This can further diminish the overall impact of automated savings in the long run.
The research findings by James Choi of Yale University and his co-authors suggest that the positive impact of automated retirement savings may be overstated. While auto-enrollment has been successful in getting more workers to participate in 401(k) plans, the actual increase in savings rates over workers’ careers is significantly lower than initially estimated.
Despite the challenges identified in the research, there is still room for improvement in automated retirement savings policies. David Blanchett of PGIM suggests that aiming for a higher default savings rate, such as 7% or 8%, could help workers save a more substantial amount for retirement. By coupling this with an employer match, workers could potentially save 10% or more of their salaries, which would be a significant improvement.
While automated retirement savings policies have shown some positive impact on increasing participation in 401(k) plans, the actual increase in savings rates over time may be less than originally anticipated. Factors such as job turnover and early withdrawal of funds play a significant role in diminishing the effectiveness of these policies. Moving forward, it is essential to address these challenges and seek ways to improve the overall impact of automated savings on employees’ long-term financial security.