Morningstar Magazine - June/July 2017 - 65

EXHIBIT 1

This decision can result in a significantly better
outcome for participants and their retirement than
if they had built their own portfolios. The
benefit of the nudge here is helping participants
avoid their worst enemy: themselves. When
investors manage their investments, many tend
to lose sight of their long-term goals (in this
case, a successful retirement) and instead focus
on short-term (quarterly or even daily) investment
results. This leads to trading, usually at the
worst times-many people buy when prices are
high and sell after a crash. A target-date fund,
which automatically becomes more conservative
as the investor ages, or other default options
help keep investors in the market and focused on
long-term growth.

Not Enough The most popular default savings rate offered by plans is 3%, which falls
well short of Morningstar's recommended savings rate of 15%.
BrightScope/ICI

T. Rowe Price

% of Plans
60

59

40

38
29

20
4

3

14

5

11

13

11

5

1
2
3
4
5
Default Deferral Rate for Automatic Enrollment Plans (%)

7
0
>_ 7

6

1

0

Source: Morningstar.

While there is debate regarding the general
efficacy of target-date funds-because they take a
one-size-fits-all approach to investing (based
only on a given age)-the introduction of default
investments has generally resulted in better
portfolios for DC-plan investors.
Automatic Enrollment
Another success from defaults is automatic
enrollment. Before auto-enrollment, employees
had to choose to participate in a DC plan.
Being human, many employees picked the easier
action: do nothing. Easier is not better, however.
The nudge flips the decision-auto-enrollment
participants must choose not to participate
in the plan. This small change has resulted in a
significant difference in plan participation.
Vanguard (2016), for example, noted participation
rates of 88% in plans that offer auto-enrollment
versus 50% participation in plans with
voluntary enrollment.
Despite the success of auto-enrollment and
default investments, there is a downside.
Defaults don't work as well if the employees aren't
nudged. Therefore, they work best for new
employees. Defaults don't have an impact on
existing employees eligible for a DC plan but who
don't participate and on employees who are
already investing in the plan. One solution is a
re-enrollment period, where all eligible employees

are defaulted into the plan. While this feature has
Participant
Weightedrare; only
Planabout
Weighted
15%
promise,
it is relatively
of
plans offer
Average
Initialit.Deferral Level (%)
8
Auto-Escalation
Another nudge available to many plan sponsors
6
is auto-escalation, where savings rates are
automatically increased each year (unless5.1
4.3of the feature).
4
the participant
opts out
Auto4.1
4.0
escalation is3.0
commonly offered alongside
62% of plans offering autoauto-enrollment-
2
enrollment also offered auto-escalation.2
0
2
3
4
Early research by Thaler and Bernartzi (2004) noted
Default Savings Rate (%)
the potential benefit of getting DC participants
to commit to future higher savings rates (to "save
more tomorrow"). Despite its promise, though,
auto-escalation has not been widely adopted. For
example, DCIIA (2015) noted that only about
half
of plansSavings
offeredLevel
the feature.
Average
Across Respondents

Default Savings Rates
So far, according to our research, defaults
appear to have resulted in better outcomes for
DC-plan participants. Things take a turn
7.6 at default
for the worse, however, when we look
7.0
savings rates.
6.4
5.9

For a4.8
plan with auto-enrollment, the plan sponsor
must select a default savings rate, or the amount
that is deducted from the participant's paycheck.
This is the savings rate selected for participants
who don't select a rate themselves. We find
that default savings rates tend to be relatively low
5
6
compared with estimated rates required to reach
most people's retirement goals. For example,
the most popular default savings rate today is 3%,
selected by approximately 50% of DC plans.3
This rate is significantly lower than the required
total pretax savings level (which includes employee
deferrals and employer contributions) to achieve
a successful retirement. In Blanchett, Finke, and
Average Savings for Respondents Who Don't
that participants
need
to
Pfau (2017), we estimated
Even
when
plans
offer
auto-escalation,
most lack
Save
at the
Base
Savings
Rate
Average
Initial Deferral
Level
a nudge to participate. At T. Rowe Price (2016),
save at least 15%. Even with a 100% employer 12
68% of DC plans offer auto-escalation, but 62% of
would result in%
match, a default savings11.54
rate of 3%
11.00
10.51
9.92rate of 9.80
9.84
6%
,
less
than
half
the average
them ask participants
to
opt
in.
The
difference
in
a
total
just
9.41
9.04
9
11%
of
participants
EXHIBIT 1
rate
needed
for
retirement
readiness.
acceptance is significant:
Only
8.18
choose
provides some insight into the distribution of
6.97 to use the feature when it is opt-in
compared with 68% when it is opt-out. Again,
default savings rates based on data from T. Rowe 6
a nudge makes all the difference.
Price (2016) and BrightScope/ICI (2016).
3

2 http://www.aon.com/attachments/human-capital-consulting/pulse-impact-of-automatic-enrollment.pdf
3
6
3 BrightScope/ICI (2016), Vanguard (2016), and T Rowe Price (2016) noted 59%, 48%, and 38% of plans, respectively.

0
8

10

12

Default Savings Rate (%)

global.morningstar.com/Morningstarmagazine

65


http://www.aon.com/attachments/human-capital-consulting/pulse-impact-of-automatic-enrollment.pdf http://global.morningstar.com/Morningstarmagazine

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