What is the Right Default Savings Rate?
Don’t let the 3% typical default rate anchor weigh you down. Place your anchor to windward at 6% or higher for safety and protection.
401(k) plan sponsors who implement auto-enrollment have a critical decision to make: at what savings rate should participants save? Because participants are not actively signing up for the plan, they are not making their own decision. Instead, the company will do it for them, selecting the right level of savings for all employees. This is a big responsibility for companies and getting it right will make the difference between a sufficiently saved population and one that will remain in the workforce beyond traditional retirement age.
Understanding the 3% anchor
Anchors can either hold someone steady or drag them down. They set an expectation and become a shortcut in people’s minds making it harder for them to process information that may point to a different, possibly more appropriate, fact.
In the 401(k), 3% has been the traditional annual default savings amount. It’s clear that participants need to save closer to 10% - 20% each year for savings sufficiency. But asking decision makers to approve a change from a 3% savings rate to a 20% savings rate is a total non-starter. They’d be bracing for an employee rebellion. It’s clear to get to the savings level participants need, we must break the decision down into smaller steps and create a path for the participant to gradually achieve the greater savings level.
How to not use 3%
Let’s say, like many others in your industry, you have a 3% default savings rate. You know it’s not enough for participants and you hear about other plans that have increased the default savings rate to 6%. Still, you need to make a decision, but you worry about two things: 1) can you get the administrative decision makers to approve doubling the default savings rate? 2) will participants be upset that you are “taking” even more money from their paycheck?
Reframing the default
For decision makers and participants alike, the tactic is to reframe the default. In some situations, this can be done in a single presentation to decision makers and communication to participants. In other cases, in a particularly cynical environment, or one where there’s some financial hardship, it may take a series of discussions and communications to prepare the decision makers and participants alike.
With decision makers:
- Lay the groundwork. Start wondering aloud if participants in your plan are saving enough. Share research that participants will need to save 10-20% of their annual income to have sufficient savings at retirement. Is 3% the right level for a default rate?
- Get the data. Start researching the savings levels of participants in your plan. What percentage of the population is saving less than 3%? How many are saving at exactly 3%? How many are saving more than 3%?
- Project the future. How it is in the participants’ best interest to increase their savings rate now to impact their future financial health? What power does compounding have to grow a nest egg? How does it improve their chances to be able to retire when they wish to?
- Drive employee engagement. Benefits are a tool for the company to drive employee engagement. Most people know they should be saving for retirement and be saving more. Research shows that participants who focus on retirement, recognize their high-quality plan, and appreciate their employer for providing it, have higher employee engagement.
- Determine the impact. Understand the impact to your company of your participants not saving enough. Combine the “under-saved” population with the “not saving at all” population. What percentage of your population could be unprepared to retire? If people start working longer, when does this begin to affect your business in terms of lost productivity and additional health care and disability costs?
These steps may not all be necessary, but taken over time, one or more of them will likely get you the vote you’re looking for to increase the default savings rate.
- Communicate wisely. No one likes to hear that they’ll have to double their savings rate. So, rather than saying: “We’re doubling your default rate, now you’re saving 6%,” say: “Research shows you should save 10%-20% of your income for retirement. Right now you’re saving 3%. We’re going to help you start to save at 6%. It’s a small step in the right direction.”
- Activate the match. A great way to incent savings is through a company match. Let’s say you have a match of 3%:
- Remind those saving below the match threshold that this increase will automatically make them eligible to receive a more match money. For participants who were saving at 1%, they’ll get an additional 2% from the company.
- Relate the savings update to the match. You can either stretch the match if it was a 3% match before ($1 for $1 up to 3%) or convert it to your 6% goal ($0.50 to $0.50 on the first 6%). By aligning the default savings rate with the match you’ve created a new incentive to save at 6%.
- Reassure. Remind participants that if it is truly too hard for them to save right now, they can opt out. Maybe they can save more later. Set up a plan design cadence so that you occasionally reach back out to try to boost savings back up to 6%.
In these examples, 6% is the new 3%. Is that the right level for a default savings rate? Probably not. But taking a step to increase the default savings rate even a little bit is important work. According to one survey, most large plans have now moved to a 6% default rate. Combined with more savings through automated annual increases, for example, it’s an important first step to get people saving more.
Don’t let the 3% anchor weigh you down. Place your anchor to windward at 6% or higher for safety and protection.
Laraine McKinnon is the author of “Known: How to Create a Great 401(k)” (© 2020, LMC17, LLC) and serves as an Advisor to Betterment for Business. She is founder and CEO of LMC17, a strategic consulting firm that focuses on hard-to-solve problems in the human resources and talent arena.