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Thresholds drive 401(k) participation more than rates

In a 401(k) or similar defined contribution plan, the “threshold” is the limit at which participant contributions are matched by the employer. According to a new report, a higher match rate (for instance, offering an employer match of 80%, rather than 50%, of an employee’s contribution up to 6% of salary) has only a small effect on savings plan contributions. In contrast, raising the match threshold (for instance, matching 50% of an employee’s contribution up to 10% of salary, rather than up to 6%) has a substantial impact.

That’s probably because “[the threshold] serves as a natural reference point when individuals are deciding how much to save, and may be viewed as advice from the savings program sponsor on how much to save,” according to Brigitte C. Madrian, the Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School of Government. She is the author of a July 2012 report, Matching Contributions and Savings Outcomes: A Behavioral Economics Perspective, from the National Bureau of Economic Research, a nonprofit organization that undertakes economic research on behalf of public policymakers, business professionals and the academic community.

Moreover, changing the matching formula from 50% of the first 6% of salary to 25% of the first 12% of salary would not increase the cost to the employer but is likely to result in employees saving more -- although without effective communications there is a risk that employees might perceive the lower rate/higher threshold as a match reduction.

The report reviewed a large body of research literature focused on encouraging individuals to increase their savings. The approaches undertaken included changing the structure of the match within a savings plan and introducing variations in which some individuals were offered a more generous match than others.

Default contribution rate impacts savings

While including a matching contribution increases 401(k) savings plan participation and contributions, it has less impact than implementing automatic enrollment or taking other behavioral approaches, according to Madrian’s research.

“Behavioral approaches to changing savings plan outcomes -- including automatic enrollment, simplification, planning aids, reminders and commitment features -- potentially have a much greater impact on savings outcomes than do financial incentives, often at a much lower cost,” she observed.

By far the most effective method to increase participation in defined contribution savings schemes is automatic enrollment, the research indicated. “Matching is not completely irrelevant in plans that have automatic enrollment. A more-generous match is associated with higher participation rates,” Madrian found.

Automatically enrolling new employees into employer-provided 401(k)s, 403(b)s and other defined contribution plans is becoming more popular (used by 39% of employers, according to the Society for Human Resource Management’s 2012 Employee Benefits survey report).

However, “Although automatic enrollment leads to unambiguous increases in savings plan participation, its effects on savings plan contributions depend very much on the default contribution rate at which individuals are automatically enrolled,” Madrian noted. “Just as the match threshold for savings plan contributions attracts the largest share of savings plan participants when there is a match, so too does the automatic enrollment default contribution rate when there is automatic enrollment. Contributions are higher with a higher default contribution rate under automatic enrollment than with a lower default contribution rate.”

For instance, in one study that Madrian described, “with a default contribution rate of 6% of pay, which coincides with the match threshold, almost half of employees contribute 6% of pay to the plan.”

Stephen Miller, CEBS, is an online editor/manager for SHRM.

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