Expert insight
The next frontier of retirement plan design: 4 big ideas
March 13, 2024
Over the last decade, harnessing the power of defaults has helped improve retirement plan design and participant outcomes. Today, most plans automatically enroll employees, increase their savings rate each year, and invest their balances into age-appropriate portfolios. These features have led to meaningful improvements in participation and savings rates, as well as increased diversification in participant retirement portfolios.1
What is the next frontier of plan design? Might we aim to promote financial wellness for workers not just in their current jobs but over the course of their careers? Might we design the next generation of features with an eye toward equity and even short-term needs? We have four big ideas worth exploring.
Smarter default savings rates: Although most people increase their income when switching jobs, they might also decrease their retirement savings rate. For example, a worker could auto-enroll in a company plan at 3% and then increase their savings rate to 8% over five years, but go right back to 3% upon taking a new job with another company.2 The typical American has nine jobs over the course of their career, resulting in repeated slowdowns in savings and potentially 35% less money saved at retirement.3 Increasing the default savings rate or nudging new hires to save at their prior rate could go a long way toward maintaining valuable momentum during job changes.
A qualified default investment alternative (QDIA) for individual retirement accounts (IRAs): There is a material cash drag in IRA accounts.4 Many workers roll their funds into an IRA when they switch jobs, but because IRAs do not have a QDIA, investors must actively choose a portfolio allocation.5 And, sadly, many do not. As a result, their assets stay in cash for long periods of time, missing out on the potential for significantly higher returns and the power of compounding. Vanguard research shows that 28% of rollovers that entered Vanguard as cash were still in cash seven years later.6 This cash drag is even greater for younger investors and smaller rollovers.7 Enabling QDIAs for IRA accounts would allow IRA investors to benefit from the power of good investment defaults just as 401(k) participants have.
“Maximizing” the match for equity, savings, and cost: Currently, the typical employer match formula rewards those who can and do save the most—workers with higher incomes, education, and family wealth.8 When evaluating match formulas through three criteria of equity, savings, and cost, no single formula stands out in terms of savings, but dollar caps are more equitable and control costs. This presents a potential cost-neutral opportunity to increase equity and savings: Employers might consider using dollar caps to help pay for plan features that do a better job of promoting savings, such as auto-enrollment or a higher default savings rate. Recognizing that employers have different objectives, these criteria can help them evaluate and maximize their existing contributions to meet their plan goals.
Automatic repayment for emergency withdrawals: The SECURE 2.0 Act that became law in 2022 permits $1,000 penalty-free emergency withdrawals with the hope of encouraging more workers to save for retirement and benefit from the employer match. How do we help savers balance their short- and long-term needs? We see that participants who take 401(k) loans continue making regular contributions while repaying their loans.9 This suggests that participants might be able to “repay” their withdrawals on top of their regular contributions. If plan sponsors nudged participants to automatically repay their withdrawals, workers would be able to access their savings in the short term without compromising their long-term financial wellness.
To close the retirement savings gap, we must continue to innovate. Smarter contribution defaults and an IRA QDIA could help job-switchers maintain their momentum in saving for retirement. Match formulas with dollar caps can help ensure employer contributions go to those who need them most. Emergency withdrawals with automatic repayment could give savers access to liquidity without leakage. These innovations are worth exploring as we push into the next frontier of plan design.
1 Clark, Jeffrey W. and Kevin D. Kukulka (Vanguard 2023). Generational changes in 401(k) behaviors.
2 Indeed, the most common default savings rate is still just 3% (Vanguard 2023).
3 Bureau of Labor Statistics, 2022. Current population survey.
4 There was $12.7 trillion in IRA accounts in 2020, according to IRS SOI Tax Stats Accumulation and Distribution of Individual Retirement Arrangements. In 2021, according to the Employee Benefit Research Institute (EBRI)/Investment Company Institute (ICI) (2021), Frequently Asked Questions About 401(k) Plan Research, there was $6.7 trillion in 401(k) dollars.
5 According to the IRS, in 2020, 88% of the $701 billion in total IRA inflows came from rollovers, with the remaining 12% coming from direct contributions.
6 Much of the $600-plus billion flowing to IRAs each year through rollovers enters the IRAs as cash. A primary driver of rollover cash is transfers between financial institutions: In cases where the IRA provider is different than the 401(k) recordkeeper, the 401(k) assets must generally be liquidated and moved as cash. According to a research report conducted by Hearts & Wallets in 2022, about 40% of rollovers involve transfers between institutions, so the share of rollovers moving as cash is likely at least as large.
7 Our findings align with research from other industry sources. For example, an ICI study (Holden, Sarah and Steven Bass (2018). The IRA Investor Profile: Traditional IRA Investors’ Activity, 2007–2016) showed that among rollovers between $1,000 and $5,000 in 2008, over 40% were entirely invested in money market funds seven years later. EBRI also documents a large cash allocation post rollover, especially for low-balance investors (Comparing Asset Allocation Before and After a Rollover From 401(k) Plans to Individual Retirement Accounts, 2019).
8 National evidence is documented in Choukhmane et al., (2023). Who Benefits from Retirement Saving Incentives in the U.S.? Analysis of 1,365 plan records kept by Vanguard between 2013 and 2022 shows that top earners receive 43% of W-2 income and 39% percent of benefit income, compared to 44% of employer contributions.
9 Beshears et al. (2024). Does 401(k) loan repayment crowd out retirement saving? Evidence from administrative data and implications for plan design.
Related links:
- The Vanguard Retirement Outlook: A national perspective on retirement readiness (31-page PDF, issued July 2023)
- Retirement readiness: Seeking solutions that benefit all Americans (commentary, issued October 2023)
- The state of retirement in five figures (infographic, issued October 2023)
Notes:
All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
There are important factors to consider when rolling over assets to an IRA or an employer retirement plan account or leaving assets in an employer retirement plan account. These factors include, but are not limited to, investment options in each type of account, fees and expenses, available services, potential withdrawal penalties, protection from creditors and legal judgments, required minimum distributions, and tax consequences of rolling over employer stock to an IRA.
