Financial Planning, Retirement

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

7/10/19 12:00 PM

/iStock-462756183.jpgThe average (median) 401(k) account balance totaled $92,148 ($22,217) in 2018, an 11.28 percent (15.62 percent) decrease from 2017, according to the latest update to Vanguard’s annual How America Saves report. Some sort of decline is not too surprising since the benchmark S&P 500 index in 2018 experienced its first down year since 2015 and the largest in a decade. Stocks have surged to new all-time highs in the first half of 2019, so a similarly impressive rebound in 401(k) balances should be expected. The S&P 500, though, fell by only 6.24 percent in 2018. Why do 401(k) balances appear to have fared much worse in 2018 than the overall market?

A key explanation is the rising adoption of automatic enrollment. Indeed, auto-enrollment results in more individuals saving for retirement, and encouragingly 48 percent of plan sponsors at year-end 2018 had incorporated this feature. That is up sharply from just 20 percent a decade earlier, and two-thirds of all new 401(k) participants last year had joined their plan under automatic enrollment, according to Vanguard. However, since auto-enrollment results in the creation of a lot of brand new accounts with no accumulated savings balances, it can weigh down certain headline statistics, e.g. the average 401(k) balance has risen by only 33.39 percent since 2009, and the median account balance has actually fallen by 3.99 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 2013 has surged by 78 percent over the past five years, and more than 90 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, nearly half of plans in the Vanguard sample automatically enrolled participants with a beginning contribution rate of 3 percent or less in 2018.

Although a welcome decline from 73 percent in 2009, 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 23 percent of plans in 2018 even auto-enrolled workers with an initial contribution rate of 6 percent or more, a marked improvement from just 9 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 generally, achieving old-age financial security could prove to be quite difficult without an adequate 401(k) contribution rate, and the belief that Social Security will be able to make up for any savings shortfalls is potentially dangerous. Just look at an earlier survey conducted by the Nationwide Retirement Institute which found that roughly a quarter of recent retirees said that their benefit from the government ended up being “less” or “much less” than anticipated. 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