Yesterday, Fidelity Investments released its third-quarter 401(k) data which showed the tremendous effects on personal savings rates that the Personal Protection Act (PPA) had in the five years since it was passed in 2006.
The goal of the PPA had been to shore up employee pension plans, which were often underfunded. The previous law left many employers to choose a Defined Benefits plan, in which employee pensions were pooled together and managed by the company. This created significant problems as pensioners and management frequently disagreed as to whether or not the size of the pool was large enough to cover everyone.
The PPA changed the pension laws to encourage employers to develop Defined Contribution plans. Rather than grouping employees’ pensions, Direct Contribution plans set up individual accounts that could be carried over from one company to another largely tax free. Additionally, auto-enrollment was developed, allowing employers to automatically begin contributing to employee’s retirement accounts. These two effects meant a significant increase in personal savings rates and significantly more protection for retirees.
Fidelity’s quarterly results show that both employees and employers have jumped to take advantage of the new Direct Contribution plans. Now, more than half of Fidelity’s 401(k) participants are in an auto-enrolled plan, compared to 16% in 2006. Auto-enrollment has paid a big role, as only 55% of workers without auto-enrollment participate in savings plans, compared to 82% of those who are automatically enrolled and given the option to leave. This distinction is even more important to younger workers: 76% of Generation Y workers auto-enrolled chose to stay in the plan, verses 20% who chose to opt-in, if not placed in initially.
Why are these results so important? These dramatic increases in enrollment rates show that individual pension plans and auto-enrollment are the keys to increasing personal savings rates. By setting up individual plans and auto-enrolling people in them, people use them as a savings vehicle to retire. This makes the worker self-reliant, rather than being dependent on the company to manage their retirement.
This last point is underscored by the asset allocation of the plans: today more than 75% of plans are target date funds, designed to become less risky as the worker grows older. Five years ago, only 12% of funds were target date funds, the remainder being short term, implying that the pensioners were not expecting to use this money for retirement.
These strong results show that the PPA was a rare Congressional home-run. The preference of Direct Contributions and the success of the auto-enroll programs provide a strong model for the future on setting up pensions and retirement programs.