Wednesday, April 3, 2013

Does 401(k) Auto-Enrollment Work?

It was hailed as one of the great ideas to come from the Pension Protection Act of 2006 (PPA). Auto-enrollment, technically known as an Automatic Contribution Arrangement (ACA), was supposed to be a revolutionary change to 401(k) plans that would allow participants in this generally non-defined benefit world to someday retire comfortably.

The IRS submitted a Compliance Questionnaire to 1200 401(k) plans that had filed Form 5500. If you are interested, you can read their report for yourself. To me, one of their key findings was around plans that use ACAs. Of participants eligible for ACAs, here is the actual data:

  • 43% defer at the default rate
  • 29% elect a rate higher than the default rate
  • 7% elect a rate lower than the default rate
  • 21% opt out of participation entirely
In my experience, the most common auto-enrollment rate is 3% of pay. If that is truly representative of US companies at large, then 71% of participants are deferring 3% of their annual compensation or less. 

That's not good. Even for participants who defer for quite a long time, annual deferrals of 3% of pay, even with employer matching contributions added to them will not get anyone to a comfortable retirement.

One of the types of ACAs available to plan sponsors is a qualified automatic contribution arrangement (QACA). QACAs generally provide for auto-escalation in default deferrals. Oversimplifying somewhat, a QACA must have a default deferral percentage of at least 6% of pay in the third year following the initial period and cannot increase to a rate above 10% of pay. QACAs are exempt from ADP and ACP testing.

Participants in QACAs who do not opt out of the defaults will often have enough savings to retire comfortably. That's the good news. The other side of the coin is that IRS data shows that only about 5% of all 401(k) plans have ACAs and of those, fewer than 1/4 are QACAs. That means that roughly 1% of all 401(k) plans are QACAs. Many of the rest will have very few participants who will have prepared themselves through saving with sufficient money to retire.

That's not good. 401(k) auto-enrollment is not working as it should.


  1. Hi John,

    It's a mess isn't it. This train wreck was somewhat easy to see back in 2006.

    My link won't work, but please search 'Automatic Enrollment Not Perfect for Retirement Dennis Ackley.'

    Let's get over the auto-everything fad and get busy creating 401k education that works.

    I want 401ks to be successful. They are the last shot we have at a voluntary retirement program. But for them to work, we must have 401k operators -- employees -- who can use them successfully. Otherwise, we need a retirement program that does not require knowledgeable operators.
    Dennis Ackley

  2. Dennis, thanks for reading and posting. When Congress actually seeks input from experts rather than lobbyists and when recordkeepers actually care about participants (neither is likely to happen), we will probably be on the right path.

  3. Thanks For Sharing post and good news!!

    Auto Enrollment.