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CCH® PENSION AND BENEFITS — 10/8/07

“Auto-escalation” of contribution rates likely to have significant impact on 401(k) accumulations, EBRI finds

A “significant” positive impact on 401(k) accumulations is likely, especially for low-income workers, in plans featuring automatic 401(k) escalation provisions, according to a study conducted by the Employee Benefit Research Institute (EBRI).

Auto-escalation authorized under PPA

Under the Pension Protection Act of 2006 (PPA; P.L. 109-280), employers are allowed to automatically enroll employees in 401(k) plans with a default contribution rate of 3%, and to automatically increase the amount of employee contributions annually (referred to as “auto-escalation”). Employees retain the right to opt out of either the enrollment or the contribution escalation.

Lower income workers would benefit

The EBRI study suggested that auto-escalation would likely increase 401(k) contributions by 5% to 12% for participants in the highest-income quartile, rising to 11% to 28% for participants in the lowest-income quartile.

Using data from its 2007 Retirement Confidence Survey (RCS), which included estimates of the number of employees likely to opt out, the study analyzed likely “replacement rates” — that is, the percentage of a worker’s final salary replaced in retirement by an annuity purchased with 401(k) assets. The study found that, assuming all 401(k) plan sponsors immediately adopted automatic enrollment, the median replacement rates for the lowest income quartile increased from 23% to 37%, even with conservative assumptions of a 3% default contribution rate and a money-market default investment. Under less conservative assumptions of a 6% contribution rate and a life-cycle default investment, the median replacement rates for the same group would further increase to 52%.

For more information on this and related topics, consult the CCH Pension Plan Guide.

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