Nearly four decades into the 401(k) experiment, employers and policymakers may finally understand how to get the most from these retirement accounts—and it all boils down to a principle that Warren Buffett has long espoused: Keep it simple.
Nothing promotes participation and sound investment practices in 401(k) plans more than simple plan choices, according to a report from Bank of America Merrill Lynch. Last year, 79% of workers offered Express Enrollment in Merrill-administered plans followed through and began contributing to their plan. That compares to just 55% who enrolled after being offered a more traditional experience requiring choices about investment options and deferral amounts, Merrill found.
These findings jibe with other research that has found that inertia is most workers’ biggest obstacle to saving for retirement. A TIAA-CREF survey found that Americans spend more time choosing a flat-panel TV or a restaurant than they do setting up a retirement account. The Merrill report underscores the inertia factor, noting that, when considering how much of each paycheck to contribute, workers typically just choose the first rate listed.
Features like automatic enrollment and automatic escalation of contributions, with an opt-out provision, turn inertia into an asset. These features are now broadly employed and have greatly boosted both participation and deferral rates. Among companies with a 401(k) plan, 70% have some kind of auto feature, reports benefits consultant Aon Hewitt. Merrill found that plans with auto enrollment had 32% more participants, and those with an auto escalation feature had 46% more participants increasing their contributions.
Merrill oversees $138 billion in plan assets for 2.5 million participants and credits simplified enrollment for big gains in the number joining a plan or contributing more. The number of employers adopting Merrill’s simplified Express Enrollment more than doubled last year. Meanwhile, the number of participants raising their contribution rate jumped 18%.
A key feature of any simplified enrollment system is that workers are put into a diversified and age-appropriate target-date mutual fund, or some other option with similar characteristics, and that they begin deferring 5% or more of pay—generally enough to fully capture any employer match. Many employers also add auto escalation of contributions to keep up with raises and inflation—or to catch up if the initial deferral rate was lower. In many plans, the default rate is just 3% of pay.
Merrill found that 64% of employers now have plans with both auto enrollment and auto escalation. One in four employers who did not have both plan features in 2013 did last year.
Taking simplification further, more employers are now using the annual health benefits enrollment period to educate workers about 401(k) plans, Merrill found. As a result, twice as many workers enrolled in a plan or raised their contribution rate the second half of 2014 vs. the first half—a trend that Merrill says has been in place for several years.