How Americans could save $83 billion with one tweak to the 401(k) system

There are three bipartisan retirement-related bills that the House and Senate are attempting to reconcile before the end of the 2022 legislative session (generally referred to as "SECURE 2.0"). The House bill includes one simple feature — automatic enrollment — that has the potential to enable greater financial security for millions of hard-working Americans.

There's a looming retirement crisis in the next few decades if we don't get smart and creative about how to close the $28 trillion retirement gap in the U.S. (the difference between what we've saved and what we'll need to spend when we retire, estimated as of 2015). Auto-enrollment has the potential to be a game-changer in attacking glaring inequities in our current savings system, where millions historically have not had access to the same savings tools as those in higher income brackets. 

Auto-enrollment means that a company's newly hired employees are, by default, automatically enrolled into a retirement savings plan, setting them up to have a specific percentage of their paycheck set aside for retirement. This is a core feature of many employer 401(k) plans, and employees across the country are already benefiting from it. A 2020 report found that auto-enrollment is the primary model among U.S. plans, with increasing adoption over the past few years (69% of all plans in 2018, 9 points higher than it was in 2016).

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The alternative to automatic enrollment is self-enrollment, which requires employees to opt in to the plan to begin receiving benefits. The auto-enrollment design is more popular among employers because it helps more employees take advantage of company retirement benefits. Vanguard found that their auto-enrollment plans saw increased participation by nearly 50% (93% compared to only 66% in voluntary enrollment plans). Among new hires, auto-enrollment tripled the participation rate, giving new access and visibility to employees who once thought 401(k) plans were only for higher-income people. For someone making the average private sector salary of $58,000 per year and saving roughly 7% of their paycheck, that amounts to roughly $270,000 in retirement savings over a period of 30 years, assuming an annual market return of 5% (of course the market return will not be constant over that time — and it's possible to even lose money). 

So why does auto-enrollment work so well? It's a brilliant nudge that takes the behavioral biases that otherwise make it difficult to save for the long-term and uses them to our advantage. Two examples are behavioral inertia and social proof. Behavioral inertia is something almost all of us recognize in ourselves. When the effort required to do something (e.g. opt-out of your company retirement savings plan) is greater than the effort required to stick with the default, we are likely to leave things as they are. On top of that, we often yield to social norms (a.k.a. "social proof") and conform to what others do and think, especially when we are uncertain. A Human Interest study found that 81% agreed that they would either enroll or increase their savings contribution if they learned the majority of their coworkers were already enrolled.

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If auto-enrollment is so good for employees, then why do some plans choose not to offer it?

There are several misconceptions about auto-enrollment that may be slowing down adoption. Here are a few commonly cited reasons for not offering auto-enrollment — followed by the response I would give to an employer who is requiring employees to self-enroll (e.g. to opt in vs. opt out): 

SECURE 2.0 hasn't been written into law yet. I am hopeful about passage of this landmark bill, but given the state of politics, it's best not to wait for Congress. Often the biggest retirement providers wait until regulators require them to act in employees' best interests. But why wait? Each week that goes by when new employees are not automatically enrolled as they onboard means thousands are being left on the retirement savings sidelines. This translates to real missed opportunities happening right now — 2.74 million employees started new jobs in the first half of 2022, and hundreds of thousands of those who work for companies without auto-enrollment have already missed out on starting retirement savings. 

It's too expensive. Some small businesses that offer to match employee retirement contributions may feel that the cost of the employer match is too much for their bottom lines. Employers don't have to include a match as part of their plan design, but if they already have one and auto-enroll pushes enrollment higher, the match cost will rise, too. The good news is that most match programs are flexible, so a match can be adjusted according to what makes sense financially for the business after auto-enrollment is put in place. Another way to keep costs down is to perform a full review of your plan costs to ensure it's competitively priced on employer fees, employee fees, and that there are no hidden 401(k) transaction fees. 

We shouldn't push people into investing. This is a somewhat paternalistic outlook, arguing that if people don't fully grasp sophisticated investing techniques or strategies, they risk losing money once they "get in the game." You don't need to be an experienced investor to realize returns in a retirement savings account. Today there are tools that automate the process and help build a portfolio even for those who want to "set it and forget it." Auto-enrollment is not pushing anybody (everyone can opt out) — instead, it empowers those who may have otherwise thought that the 401(k) wasn't for them. It can be  especially important to begin investing during the inflationary times we live in — when inflation continues to rise and your money is sitting in a bank account that isn't earning a meaningful rate of return, you are literally losing money as your dollars become less valuable. 

The stock market is shaky right now, why should we auto-enroll people in that kind of market? To succeed in savings, you have to play the long game. Today, when some stocks are lower, may even be the best time to start a 401(k), assuming you are willing to hold investments for years and decades instead of months. Auto-enrollment at any time makes sense because we know that, in the long run, it can be instrumental in increasing lifetime savings. 
 
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Auto-enrollment by itself won't fix the retirement savings gap. However, it could make a significant dent and would be a huge step forward for America. We estimate that if all employees with access to a 401(k) who aren't participating were automatically enrolled overnight at a 7% deferral rate, Americans could save $83 billion in just one year, and this doesn't even consider the 42 million employees that don't yet have access to a 401(k).

There are those in this country who have enjoyed saving their entire career — union members with pensions, or workers who went to large companies where they were automatically enrolled in their 401(k) from the start. Let's deal some cards to the other American workers who traditionally have not had access, or who may have opted out in the past without knowing the consequences. Every American, including hourly workers and those who work part- or full-time, should have the same savings tools at their disposal so that they can build a secure financial future.