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More Workers Get in on 401(k)s

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar. Each year, Vanguard releases a report detailing how and what investors in Vanguard-managed company retirement plans are doing. I recently sat down with Jean Young at Vanguard to discuss some of the findings.

Jean, thank you so much for being here.

Jean Young: It's my pleasure.

Benz: Vanguard puts out an annual How America Saves report that looks at 401(k)-plan and other company-plan participant behavior. Let's talk about some of the findings. In a lot of ways, some of the numbers here are pretty encouraging. One is that you've seen an uptick in participation rates. Let's talk about some of the numbers that you are looking at there.

Young: Over the past decade, we are seeing a general uptick in participation rates, probably from around, I'd say, two thirds when you look at the participant--the individual level--to north of 75%. And all of that improvement is attributable to the rising adoption of automatic enrollment. About a third of the plans we work with have adopted automatic enrollment, and automatic enrollment tends to have been adopted by larger plans.

About two thirds of the participants are in plans that now have automatic enrollment design. So, we're seeing this steady uptick in participation rates, which is a good thing.

Benz: One thing that goes hand in hand with participation rates is contribution rates. And one thing that I know that you noted in the report is that the participation rate may go up, but contribution rate doesn't necessarily follow suit, and those two things are connected. Let's talk about that relationship.

Young: There's been a small dip in the average contribution rate, although the median contribution rate has been perfectly flat for the last 10 years, at 6%. But we've seen a small dip, on average, from 7.3% to around 7% in the average contribution rate. And that is all attributable to the designs that plan sponsors choose for automatic enrollment. Half of plan sponsors choose 3% as the default deferral rate.

Now, the good news is that 69% of the plans we work with also have implemented annual increases. So, as long as you couple the annual increase in with the default deferral rate, you're going to get to, typically, a decent savings rate.

The other thing is that people focus on the individual deferral rate, but we're also able to measure the aggregate or total contribution rate. Ninety percent of the plans we work with do make an employer contribution, either a match or a profit-sharing type of contribution--or sometimes both. And when we look at the aggregate contribution rate, on average, it's around 10%. And at the median, it's close to 10% as well.

So, while we would suggest that our participant base needs to be targeting a total savings rate of 12% to 15% or more, certainly you don't hear a lot about the fact that the typical participant is saving 10% in these plans.

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Benz: In terms of choices, in terms of the investment options that people choosing, you have also observed a greater uptake of managed sorts of products--mainly target-date funds but also other versions of managed investments. Let's talk about the data there. What's driving that? Is it that the opt-in--the automatic enrollment for a lot of 401(k) plans--is into the target-date vehicle?

Young: First of all, let's take a step back and say that this [shift to managed products] is the How America Saves headline and has been for the last couple of years. We're record-keeping over 3.4 million participants, and 40% of them were solely invested in a professionally managed allocation at the end of 2013. Thirty-one percent hold that single target-date fund; another 6% hold a balanced fund--in our case, that's very likely the Balanced Index Fund (VBAIX) or the [Vanguard Wellington Fund (VWELX)], both good options. And then 3% of the participants have signed on for the managed-account program.

So, they've turned the portfolio-construction task over to, in our case, financial engines. This is huge. We project that this will be up to 60% in just five years. And in fact, if you look at the new plan entrants in 2013--what I would consider the class of 2013--75% of those plan participants are solely invested in a professionally managed allocation. And what we are seeing, as a result, is better portfolio construction.

We broadly characterize a participant as holding a balanced portfolio if they hold between 40% and 90% equities. Ten years ago, about a third of participants had that allocation overall. Today, we are up to two thirds. And so those extreme allocations--over-concentration in company stock, no equities, 100% equities--we've seen the portion of participants holding those extreme allocations also fall by about half.

So, the rising adoption of professionally managed allocations is huge, and it is largely driven by the rising adoption of target-date funds. Now, I mentioned earlier that a third of the plans have automatic enrollment; two thirds of the participants are in the design, but only half of those sponsors with auto-enrollment swept everybody and there is certainly a population that was in the plan before automatic enrollment was implemented. Our estimate is that about half of the target-date fundholders, single or mixed, have chosen the target-date funds and the other half got there through the auto-enrollment design.

The important thing is to offer the option, because if you think about the enrollment scenario for somebody that's got to get into this plan under voluntary enrollment, the first thing they have to do is they have to decide to cut their paycheck. So, they have to decide how much they're going to save, and that results in less take-home pay. That decision is probably a little bit easier for individuals. They know they should at least get their full employer match, and they've heard this 10% number.

[And, by the way, over 80% of enrollment transactions are self-processed online by participants.] So, once they get through that screen, then they're faced with selecting their investments, and that is a daunting task for many, many individuals. But when you position the target-date fund as a diversified one-stop option, it simplifies that whole enrollment process for them. So, I think it is important to acknowledge that participants are choosing these funds as often as they're being defaulted into them.

Benz: Another thing I think a lot of people have been monitoring is the role of 401(k) loans. Especially during the financial crisis, we saw a little bit of a spike in the number of loans being taken. Let's talk about the data that you see, the sorts of trends that you see in 401(k) loans. Are you satisfied with what's going on in the realm of 401(k) loans or is there any cause for concern there?

Young: First of all, in the financial crisis, we actually got to the lowest point of new loan issuance in these plans. And then we did see, coming out of the financial crisis, more loans being issued. Frankly, I don't worry about loans. The reason I don't worry about loans is that we know that 90% of loans are repaid; as long as the loan is repaid, it does not represent leakage from these plans.

The other thing about loans is, as research suggests, they resolve liquidity concerns for some individuals. And one of the charts we have in the publication is one where we take a look at the population that earns less than $30,000. And overall, in the population earning less than $30,000, 56% of those individuals are not saving in their workplace savings plan through payroll deduction. And if they're not saving here, they are likely not saving outside of the plan.

Now, if you look at the participants--the contributing individuals who earn less than $30,000--a quarter of them do have a loan outstanding. So, they are the highest loan users. But I would suggest that the 11% of lower-wage individuals with a loan outstanding are way better off than the over half of individuals who are not saving at all. So, I don't worry about loans. I know they're repaid. Ideally, nobody would have a financial crisis. Ideally, everyone would have three to six months of emergency savings; but the reality is, for that demographic, that's a hard thing to do. I suspect for the folks with no retirement savings to tap, when they face a financial crisis, it's a lot tougher [for them than it is for] this group that has some retirement savings to borrow from.

Benz: The last thing I want to focus on with you is participant balances. When you look at average balances, certainly we've had a very strong equity market that has certainly benefitted a lot of 401(k) plan participants. Let's talk about where average balances are today, how that stacks up to where they've been historically, and get your takeaways from the direction of balances.

Young: Well, our average balances are at a record high, and virtually all of the major record keepers reported record-high average balances at the end of 2013. The balances have recovered from their lows during the recession and the market crisis. And account balances, frankly, are at the metric that gets us in trouble when pundits look at the viability of the system. This is very much cross-sectional data.

So, the average account balance at the end of 2013 was $102,000--certainly not a number any one of us wants to depend upon in retirement. But it's important to keep in mind what that represents. It's cross-sectional, as I mentioned. The typical participant has eight years of tenure, is 46 years old; we know they're saving 10%. We know they likely have a balanced portfolio.

So, what you have is a situation where your highest-balance participants are rolling out. Ten percent to 15% of them take their money from the plan every year. That's not to say they spend it. It's largely preserved. It's rolled over to an IRA. And then at the other end, you have people coming in for the first time with zero. So, there is a lot of churn in this data.

And the other thing, too, is that any individual retirement plan account balance is an incomplete picture of the assets a household has accumulated for retirement. Hopefully, our 46-year-old participant has assets from a former employer. We're not seeing the value of the house; we are not seeing any aftertax accumulations. And in addition, if there's a spouse, we are not seeing any spousal assets. So, it's very much an incomplete picture.

Benz: Jean, thank you so much for being here to share these findings with us.

Young: Thank you.