Little Pushes Can Drive Big Plan Improvements

New research from Morningstar argues retirement plan advisers and their sponsor clients can benefit from “nudging” employees toward better behaviors. 

Sponsors of defined contribution (DC) plans spend plenty of time and effort on strategies to boost participation rates; however, high participation levels alone don’t necessarily indicate a healthy plan.

According to research by Morningstar, about half of DC plans offering automatic enrollment place their new participants at a “low” and “inadequate” savings rate of 3%.

The firm’s latest research paper surveys thousands of participants and explores different ways to increase deferrals. The firm points out that participants accepted the default savings rate at roughly the same level, whether it was set at 3% or 12%. Moreover, those who choose their own savings level tended to opt for higher rates over the plan sponsor’s chosen default. Morningstar believes the default rate may even serve as a mental “anchor,” leading employees to incorrectly visualize where the acceptable starting point is. The firm concludes, “The results strongly suggest that increasing default savings rates is likely the simplest and most effective way to get participants to save more for retirement.”

The firm finds that 68% of plans recordkept by T. Rowe Price offer auto-escalation as an opt-in feature, but only 11% of participants choose to use this feature. Moreover, these features could be undermined by employee turnover, especially when a worker changes employers and finds they have been defaulted into a lower savings rate. Morningstar finds that the median employee turnover rate is four years for all American workers, and less than three years for those younger than 34. Unfortunately, many employees don’t carry over their previous savings rate.

The conclusion is that plan sponsors may be able to benefit from “nudging” employees toward better behaviors. This could include utilizing higher-than-average default rates, utilizing re-enrollment for current employees, or applying higher auto-escalation rates via an opt-out feature. Effective communication must also be implemented to minimize employee push back. Morningstar also notes that plan sponsors “concerned about the potential additional costs associated with higher levels of participation (and higher savings rates) could consider stretching the match to a higher level and/or changing the match rate to a discretionary formula, i.e., one that can be adjusted based on actual participant savings levels/costs.”

The employer match could be an effective incentive to get participants to save more. The paper suggests that instead of offering a 100% match on the first 3% saved, an employer could offer a 50% match on the first 6% saved, “thereby increasing the contribution rate at no cost to the employer.”

Moreover, Morningstar finds that communication and advice could also have a positive effect on savings rates. According to its research, 90% of participants who engaged with in-plan solutions such as robo-advice increased savings rates by about 2%. Morningstar says, “Advice solution providers should be aggressive when providing savings guidance to participants and can include recommendations on saving, investing, and when to retire.”