More Robust Use of Auto-Features
In a new report, “Design Matters,” the Defined Contribution Institutional Investment Association (DCIIA) analyzed what is working in defined contribution (DC) plans and whether additional legislation could strengthen these factors further. DCIIA concludes that plans have the tools they need to get workers prepared for retirement—they just need to use them more vigorously.
The Pension Protection Act of 2006 (PPA) was a watershed moment for defined contribution plans and has helped change them dramatically, DCIIA wrote. Before the PPA, 19% of DC plans used automatic enrollment, and today 60% do. Pre-PPA, 9% of plans used automatic escalation, and today 80% do. Stable value and money market funds were the most common qualified default investment alternative (QDIA), and today 85.5% of plans use target-date funds for the QDIA.
“The difference between retirement savings for workers in plans with automatic features and those whose plans do not have auto-features is dramatic,” DCIIA wrote. “The DC system is already equipped with many of the tools it needs to drive improved retirement outcomes. Wider and more consistent adoption of these tools, including automatic features and adequate initial savings rates, could make a significant difference for today’s workers.”
DCIIA estimates that in plans without automatic features, a person retiring at age 66 would have five times his final salary in savings, whereas a person in a plan with auto-features would retire with 6.66 times his final salary saved—more than a 30% difference.
According to DCIIA, the median initial deferral rate for DC plans is an inadequate 3%, and there is a need for more “robust defaults.” The organization believes that existing legislation is sufficient to support higher deferral rates and escalation up to 15%. It also estimates that when plans use an initial deferral rate of 6% and automatic escalation up to a 10% cap, participants could retire with 7.9 times final salary. If it is increased to a 15% cap, participants could retire with eight times their final salary.
Further, DCIIA stressed the importance of plans limiting loans, hardship withdrawals and cash-outs, as doing so could increase participants’ holdings by as much as 10%. Today, 86.6% of plans permit participants to borrow against their DC plan account, with 45.6% allowing more than one loan at a time—a definite problem, as many participants default on the loans upon job termination. DCIIA estimates that when a plan optimizes auto-enrollment with no leakage, a participant could retire with 8.54 times his final salary.