Markets, Financial Planning, Retirement

401(k)s, Automatic Enrollment, And Social Security

6/21/18 8:00 AM

/iStock-462756183.jpgThe latest How America Saves report from Vanguard was released this month and it showed that the average (median) 401(k) account balance totaled $103,866 ($26,331) in 2017, a 7.64 percent (6.55 percent) increase from 2016. At first glance such growth might seem disappointing compared to the benchmark S&P 500’s 19.42 percent jump last year, but some of the apparent lag in performance can likely be attributed to the rising adoption of automatic enrollment. Indeed, auto-enrollment results in more individuals saving for retirement, and encouragingly 46 percent of plan sponsors at year-end 2017 had incorporated this feature. That is up sharply from just 15 percent a decade earlier, and nearly four in ten (37 percent) contributing 401(k) participants last year had joined their plan under automatic enrollment, according to Vanguard.

However, since auto-enrollment also creates a lot of new accounts (with no accumulated balances), it can weigh down certain headline statistics, e.g. the average 401(k) balance has risen by 32.46 percent since 2007 while the median account balance is up only 4.50 percent. One way to better adjust for the influx of new (small) accounts is to only look at continuous plan participants. For example, the median account balance for 401(k) owners that have maintained a balance since year-end 2012 has surged by 128 percent over the past five years, and more than 94 percent of continuous participants saw their account balance rise during this period. Those figures highlight the significant wealth creation that is possible when ongoing contributions are combined with healthy market returns. Such statistics, though, could have been even better because as great as auto-enrollment is at kickstarting many Americans’ retirement savings, a more direct way that it can hold back 401(k) balance growth is by starting participants off at a low contribution rate.


Specifically, half of plans in the Vanguard sample automatically enrolled participants with a beginning contribution rate of 3 percent or less in 2017. Although a welcome decline from 76 percent in 2007, that still signals that too many plans are using what is generally considered by financial experts to be an inadequate default deferral rate. The concern could be that a higher contribution rate would cause people to quickly opt-out of a plan after being automatically enrolled but various studies have shown this not to be the case. On the bright side, more sponsors have started to abandon the antiquated 3 percent default rate, and 21 percent of plans in 2017 even auto-enrolled workers with an initial contribution rate of 6 percent or more, a marked improvement from just 7 percent a decade earlier. The use of automatic escalation has also been on the rise recently, which increases the likelihood that participants will take full advantage of an employer’s matching contributions, if available.

More importantly, for participants without an adequate deferral rate, especially among individuals who do not begin contributing to a retirement plan until later in life, achieving old-age financial security could prove to be quite difficult. Further, the belief that Social Security will be able to make up for any savings shortfalls could be dangerous because a survey conducted by the Nationwide Retirement Institute earlier this year found that roughly a quarter of recent retirees said that their benefit from the government ended up being “less” or “much less” than expected. Almost a third of respondents already retired for at least ten years reported being similarly disappointed with their realized Social Security income. An early retirement is often the cause of a reduced Social Security payout, and more than a fifth of surveyed retirees said that they would delay when they start claiming their government benefits if they had the opportunity to do it all over.



Sources: Vanguard, Nationwide Retirement Institute

Post author: Charles Couch