Recent research confirms that automatic enrollment for new hires can improve initial participation rates, but will they save enough for retirement? A study conducted by Vanguard’s Center for Retirement Research says many participants will not.

In many ways, automatic enrollment plans had positive impacts on new employees. The study, which observed 55 plans adopting automatic enrollment, showed that 86% of new employees participated in the plan, nearly twice the number of new hires that participated in voluntary enrollment plans (45%).

The study also showed that automatic enrollment received the greatest response from employees of younger and lower-income demographics, narrowing the gap between low and high-paid participants.

The downside? Over time, the study showed that contribution rates generally decreased. Under a voluntary enrollment design, new hires would have chosen a higher contribution rate to begin with (half of the 55 automatic enrollment plans offer an initial rate of 3%) but under the automatic model they tended to stick with low-default rates.

The study showed that in four out of 10 plans, total employer and employee contributions were still less than 9% after five years, a level Vanguard deemed inadequate in saving for a comfortable retirement. In fact, the company recommends employers aim for a total contribution of 9% to 12%. The study sheds light on a solution: automatic annual increases. After five years, 87% of plans with automatic increases had total contribution rates of 9% or higher.

Vanguard also suggests that clearly communicating the terms and benefits of the plan can increase enrollment activity and decrease opt outs. An additional Vanguard study found that employees who decide not to participate or contribute very little to an employer’s plan tend to have problems with financial literacy and trust.

The study emphasizes how important it is for employers to take these precautions when implementing an automatic enrollment model for new hires, particularly annual increases and targeting a total contribution of 9% to 12%. Only then will employees be able to adequately save for their future.

To read the study on Vanguard’s website, click here.

For more about auto enrollment and DC plans, click here to read Switching to Autopilot from the September 2007 issue of Benefits Canada.

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