How to use 401(k) auto programs to boost retirement savings

Isaac Newton’s first law of motion says that an object at rest stays at rest and an object in motion stays in motion. Applied to human behavior, the first part of Newton’s law translates to the fact that it is a lot easier to do nothing than it is to do something. This simple statement is both the strength and the weakness of automatic programs in 401(k) plans.

When the Pension Protection Act of 2006 made clear that plans could institute automatic enrollment programs, most early adopters mimicked the samples in the law by automatically enrolling new hires at 3%. By doing nothing, these new hires were saving, but they were saving at a modest rate.

If you’re thinking about adding or modifying automatic solutions for your plan, consider the following key points:

  • Automatic solutions are an effective way to help break through employee inertia.
  • A default rate of 6% can help get employees on a better path vs 3%.
  • Safe Harbor plans can now allow automatic increase up to 15%, as provided by the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), signed into law at the end of 2019.
  • Current automatic enrollment designs trend toward higher initial deferral rates and the inclusion of automatic increase.

Some plan sponsors were concerned that a higher automatic enrollment default rate would cause more employees to opt out. But our data shows higher automatic default enrollment rates are linked to higher employee participation.

Higher automatic enrollment default rates are linked to higher employee participation

Bar chart comparing 401(k) participation rates at different auto enrollment default rates (footnote 1)

When the auto enrollment default rate is under 3%, the overall participation rate is 79%. When the auto enrollment default rate is 3%, the overall participation rate is 80%. When the auto enrollment default rate is 4%, the overall participation rate is 83%. When the auto enrollment default rate is 5%, the overall participation rate is 85%. When the auto enrollment default rate is 6%, the overall participation rate is 82%. When the auto enrollment default rate is 7%, the overall participation rate is 85%.

1 2020 Bank of America Financial Life Benefits® Impact Report.

Auto solutions: Why they matter

Tanya

  • Starts contributing to her 401(k) plan at age 35
  • Plan matches 50% of first 6% deferred
  • Earns $50,000 annual salary with 3% increases annually

Amount Tanya may have in her 401(k) when she retires at age 65 if she does nothing and allows automatic solutions2

Bar chart showing what Tanya may have in her 401(k) when she retires at 65 if she allows automatic solutions

In this illustrative example, if Tanya automatically enrolled at 3%, she may have $301,861 by the time she retires at 65. She may have $571,406 by the time she retires at 65 if her automatic deferral rate is increase by 1% per year until she gets to 6%. If she is automatically enrolled at 6%, she may have $603,723 by her retirement date. If she is automatically enrolled at 6% and the automatic increase is extended to 10%, she may have $836,578 by retirement. If she is automatically enrolled at 6% and the automatic increase is extended to 15%, she may have $1,057,255 by retirement.

2 This hypothetical illustration assumes an age 35 starting salary of $50,000 with an annual salary increase of 3%, the indicated deferral rate (deferral weighted to the middle of each year) and a 7.0% annual effective rate of return. It also assumes a company match of 50% for every dollar contributed up to 6% of eligible compensation contributed at year end. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than their original cost. Taxes are due upon withdrawal. If you take a withdrawal prior to age 59½, you may also be subject to a 10% additional tax.

Talk with your Bank of America representative about auto solutions strategies that may be right for your plan.