Plan sponsors' choice of plan design led to record-breaking retirement saving

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Retirement plan sponsors’ widespread embrace of smart plan design helped lead to new retirement savings records in 2021 despite prominent headwinds, according to How America Saves 2022, a Vanguard report released in June that examines retirement plan data from 5 million defined contribution plan participants across Vanguard’s recordkeeping business.

“We saw record-high participation and deferral rates as well as a higher percentage of participants in target-date funds and advised solutions such as managed accounts than ever before,” said John James, managing director, institutional investment group, Vanguard.

“These trends can be attributed to the increasing use of plan features such as automatic enrollment and automatic escalation. Their growing use continues to positively affect participant behaviors and outcomes, particularly when coupled with another trend—rising contribution default rates.”

James said plan design and the actions of plan sponsors helped explain the positive trends, which occurred in a volatile environment marked by rising inflation, global uncertainty and the lingering impacts of the COVID-19 pandemic, such as ongoing supply chain challenges and a tight labor market.

“We believe this commitment to smart plan design is a big reason why participant behaviors remained largely unaffected in 2021,” James said. “Most participants simply did not access their retirement plans, and by year’s end, average account balances had increased by 10%.”

Adopting auto-enrollment

In particular, How America Saves pointed to the increasing use of automatic solutions to influence employee retirement saving behavior as a crucial reason that plan participation rates have increased.

Automatic solutions “leverage inertia for the benefit of the participant,” the report said. According to Vanguard, the adoption of automatic enrollment has more than tripled since the end of 2007. At the end of 2021, 56% of Vanguard plans were automatic enrollment plans, including 75% of the plans with at least 1,000 participants.

In addition, two-thirds of automatic enrollment plans have implemented automatic annual deferral rate increases, and automatic enrollment defaults have increased over the past decade. In fact, the report showed that 58% of plans have a deferral rate of 4% or higher – up from 32% in 2012.

“Automatic enrollment designs have become stronger, and participant portfolio construction has continued to improve with more age-appropriate asset mixes and less extreme equity allocations,” according to the report.

Improving portfolios

In addition, the report says that the growth of professionally managed allocations has led to improved portfolio construction. “Participants with professionally managed allocations have their entire account balance invested in a single target-date or balanced fund or in a managed account advisory service,” Vanguard said.

“These diversified, professionally managed investment portfolios dramatically improve diversification compared with the portfolios of participants who make their own choices,” according to the report.

Target-date funds are becoming more common, according to the report. The funds, which shift their emphasis from more aggressive investments to more conservative ones as a participant draws closer to a target retirement date, were offered in 95% of plans in 2021 – up from 84% in 2012. Participants have proven amenable to them. In fact, 81% of Vanguard participants had target-date funds, and 69% of those participants had their entire account invested in a single target-date fund.

“An important factor driving the use of target-date funds is their role as an automatic or default investment strategy … that said, voluntary choice is still important, with about 4 in 10 single target-date investors choosing the funds on their own, not through default,” the report said.

Adopting Roth 401(k) options

Among other findings related to plan design in the report, Vanguard said that 77% of Vanguard plans had adopted the Roth 401(k) option, though just 15% of participants within the plans had elected the option.

“We anticipate steady growth in Roth adoption rates, given the feature’s tax diversification benefits,” the report said.

The report also highlights the prominence of defined contribution retirement plans, which it calls “the centerpiece of the private-sector retirement system in the United States.” The report said that more than 100 million Americans are covered by defined contribution plan accounts, with $11 trillion in assets.

“DC plans are the dominant type of retirement plan sponsored by private-sector employers in the United States, covering nearly half of all private-sector workers,” the report said. “Although there is still a significant minority of individuals eligible for such plans who fail to participate in them, DC plans have nonetheless enabled millions of American workers to accumulate savings for retirement.”