At Vanguard, we are constantly looking for new and innovative ways to help investors make the best decisions. How America Saves: Small Business Edition is Vanguard's annual comprehensive assessment of plan design trends and participant saving behavior of plans served by Vanguard Retirement Plan Access™ (VRPA). For a look into how investors have responded to the global pandemic, view our How America Saves update with data for the first half of 2020.
The following are three key themes from How America Saves: Small Business Edition data, along with recommended actions that plan sponsors can take to optimize their plan design. We believe a strong plan design will serve participants well in good times and bad—including this time of extreme uncertainty caused by the COVID-19 pandemic.
The power of automatic enrollment
Automatic enrollment increases plan participation and plan deferral rates. Employees enrolled in plans with an automatic enrollment feature have an overall participation rate of 83%, compared with a participation rate of only 52% for employees hired under plans with voluntary enrollment.
Automatic enrollment has a successful track record of using the inertia inherent in participant retirement saving decisions to improve outcomes. It also helps get employees into the plan early, increasing the odds that they'll achieve retirement readiness. Finally, automatic enrollment takes the complex choice of how much to save and where to invest out of the picture, setting employees up automatically for success.
Plan actions:
- Implement automatic enrollment to help reframe the saving decision.
- Reenroll eligible nonparticipants to provide current employees with the same benefits as new hires.
- Enact continuous enrollment to encourage employees whose financial situation may now permit retirement savings.
Accelerating target saving rates
Plan sponsors are increasingly using plan design to help boost participant saving ranges. Vanguard believes participants should be saving 12% to 15% of their pay each year for retirement (through a combination of employee and employer contributions), starting as early as possible.
Source: Vanguard 2020.
Note: Comparison based on an initial deferral rate of 3% with automatic increases of 1% up to a 10% cap, compared with an initial deferral rate of 6%, with 2% automatic annual increases up to a 15% cap. In both scenarios, starting salary is $40,000 with a 1% real annual growth, and the employer match is 50% on the first 6% of employee deferrals. Returns are based on 4% real return. This hypothetical illustration does not represent the return on any particular investment, and the rate is not guaranteed. The final account balance does not reflect any taxes or penalties that may be due upon distribution. Withdrawals from a tax-deferred plan before age 59½ are subject to a 10% federal penalty tax unless an exception applies.
Plan actions:
- Default participants into the plan, starting at match level.
- Implement an automatic annual increase to get participants to their target saving rate sooner.
- Consider increasing the default saving rate for employee deferrals, as studies have shown that higher defaults won't diminish plan participation.¹
The target-date fund effect
Nearly all Vanguard retirement plans offer target-date funds (TDFs). TDFs contribute to more age-appropriate asset mixes and a reduction in extreme allocations. Seventy-nine percent of VRPA participants are using TDFs, and 63% of participants have their entire account invested in a single TDF. An important factor driving the use of TDFs is plan design, specifically the use of TDFs as an automatic or default investment strategy. Ninety-eight percent of VRPA plans in 2019 specifically designated a qualified default investment alternative (QDIA). Among plans choosing a QDIA, 97% of designated QDIAs were TDFs.
Plan actions:
- Make TDFs available to participants.
- Make TDFs your default by using a QDIA.
- Reenroll participants into TDFs to help ensure their portfolios are age-appropriate and properly diversified.
Perspective for any environment
We recognize that the retirement landscape changed drastically in the first half of 2020. With so much economic uncertainty, it's important to focus on what you can control, such as implementing automatic enrollment, accelerating total saving rates, and encouraging the use of TDFs. We hope that the key themes and actions we've identified here offer straightforward steps you can take to help optimize plan design and allow participants to meet their investing goals—in any market.
How America Saves: Small Business Edition is designed to give plan sponsors a detailed understanding of small and midsize defined contribution plans to help them make more effective decisions. Read our full report for insights into participant saving and investing behavior.
¹ Jeffrey W. Clark, and Jean A. Young. Automatic Enrollment: The Power of the Default. Vanguard research, institutional.vanguard.com.Notes:
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.
- Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target-date funds is not guaranteed at any time, including on or after the target date.
