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Are Default 401(k) Savings Rates Too Low?

By one measure, automatic enrollment has been a smashing success: It has boosted employee participation rates in 401(k) plans above 85%, compared with 67% for those plans without auto-enrollment, Aon Hewitt says.

But because two-thirds of companies set the default contribution rates at 3% of salary or less, the new trend hasn’t done much to help participants achieve the 12% to 15% annual savings rates they will need if they are going to amass an adequate retirement nest egg.

Why do most employees choose a default savings rate of just 3%? Many worry that if they go much higher, employees will start dropping out of the plan. But new evidence from New York Life Insurance Co.’s 401(k) administration unit indicates otherwise.

According to a recent study by New York Life’s Retirement Plan Services division, “higher default deferral rates in 401(k) plans with auto enrollment lead to higher participant retention.” New York Life examined 480 of the plans it administers, with a collective total of 800,000 participants. Over the 12 months that ended on March 31, those plans with default rates of 3% or less had a 14% drop-out rate, on average. In contrast, in plans with a default savings rates above 3%, the average drop-out rate was 10%.

In addition, 30% of participants enrolled in plans with default savings rates above 3% voluntarily elected to raise their savings rates within a year of enrollment, up from only 13% who did so in 2006. By contrast, in plans with default savings rates of 3% or less, 27% voluntarily raised their savings rates—about the same as the 26% who did so in 2006.

The net effect, says David Castellani, CEO of New York Life Retirement Plan Services, is that “as account balances grow, so does the level of engagement of participants” in the plan. “We see it not just in savings rates, but also in hits on plan web sites and participants’ action around investment allocations,” he says. Higher default savings rates “create a greater participant engagement level.”

For that reason, he adds, “we encourage our (plan) sponsors not only to auto-enroll, but to push the auto-enrollment envelope as far as they can,” by implementing higher default savings rates.


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    • Saying all else equal, China is just dumping bonds.Looking at the after-market bond exgahnces. That’s where the real change in value would happen, initially. The after market cost of the bond would drop significantly. That would push the yield higher. They are issued a par 100 with a 5% coupon for simple math, 2 coupon payments a year of $2.50 per $100 in bonds. The par comes down to 80 that bond still pays that exact same coupon. Now your getting $5 in coupon payments for an $80 bond. The new yield is 6.25%.Now when the government goes to issue new bonds, they would have to be pretty close to the market yield. If I can buy a 29 ytm bond with 6.25%. Why would I buy a 5% yield bond with the full 30 ytm?If your buying these bonds with the intention of holding them to expiration you get the face value back. You could come in after China dumped all of its bonds, buy them for 80, hold them, collect the coupon then cash out for 100.The money supply and things like that, typically do not have a big impact on long term bond rates. That’s more your O/N, 1, 3, 6 month type stuff. Hope that helped. Difficult to explain question feel free to email me if you are more confused than you were before.Additional response: If your going a little further in to it. You can go to They have a lot of links that really break down the maturities, total outstanding, new supply, etc.I don’t know that your going to be able to pull up “China’s Bond Holdings” exactly. There should a total of Indirect ownership, that represents foreign holdings. China owns about $730B last check, don’t quote me on that number. Not counting the intragovernmental holdings like SS, Medicare, Va holdings, DoD, etc. There are about $7.5T in outstanding bonds. So, China theoretically holds about 10% of all outstanding US Bonds. I don’t know that you can really gauge the markets appetite for for that type of excess supply. There could be some bond funds that like China being out of the equation and some that don’t like it. If the stock market is down you get a little “flight to safety” in the form of bond purchasing.Then at the same time inflation expectations might increase, the bid-to-cover on the auctions might be down. I guess I’m saying I would personally stay on the sideline, have some cash ready to deploy. If the bond market takes a turn down in price, up in yield, in some type of knee jerk fashion like a 25BP in a day, then I’d jump in.If you into fixed income some really high quality firms are issueing some A and AA paper with 5, 6, 7% coupons. I think some of the firms are at that lower tier because the rating agencies are affraid to make anything AAA anymore, like the MBS, CMBS, ABS, CDO, etc I’m not a bond trader or financial advisor. I have a personal interest in monetary policy, government and debt management. So I do a lot of research, more on the academic side.This is a commercial link, but it might answer some further questions And investopedia’s takes a shot at it As an after market play there would some immediate impact. on the face value or purchase price. So if you did believe that China was going to dump all of it’s bonds and you were buying bonds in front of that you would lose money on the initial investment. I don’t know if you can short bonds or not, but you would want to short bonds ahead of that. That would be borrowing bonds from a large institution, selling them at the market price now which has been pretty close to par. You borrow one bond at $100 you sell it, China dumps the bonds, the market value is now $90 then you buy it back and replace the borrowed bond with that same bond.Again, there are a lot of factors that affect the market. Your really looking at real interest rate, on a very generic measure is the 52-week yeild + projected inflation. New recession concerns flatten the yield curve by increasing face value of the long end bonds.A final final note. Looking at the stock market comared to the bond to the bond market. When the stock market is up bond traders are selling bonds and chasing a higher return in the market, there is your excess supply, lower face value, higher yield. The stock market turns lower, people shift to capital preservation mode and safety, increasing the demand for a safe haven like US bonds, the price goes up, yield goes down because there is an increase in demand.Excess supply causes bonds to sell at a discount.Excess supply, lower price, higher yield. Higher yields at the long end of the yield curve typically increase mortgage rates. An increase in yield on the 10-year typically directly causes an increase in mortgage rates % for %.Credit cards are typically attached to LIBOR or Prime rate. LIBOR is almost an international Fed Funds rate. That is the rate that banks lend money to each other to smooth the balance sheet out. LIBOR + 8% means that they are paying LIBOR or Fed Funds rate to fund the cash for your card, then the 8% is based on your credit score. They pool all the people with your credit rating and say we expect 5% defaults at this score, we change 8%, and have a 3% typical or expected profit.Then prime rate I THINK is the 90 dayA1/P1 commercial paper rate. That’s also a short term liquidity issue. If that credit company is tapping the commercial paper market then they are paying 3.25% (I think thats prime right now) to have the capital to fund your credit card. So they pay 3.25% for the money, then based on credit the 8% Anything 2 years or longer should be coupons, so they would not compound unless you re-invested the dispersement into more bonds.

    • You are right Annabella. The 401(k) is designed to make money for the financial industry. It has never been an effective product for the majority of plan participants, and it never will be. We need to stop pretending that the 401(k) is a retirement plan, and demand that the financial industry design a plan that really gets the job done.

    • ‘Why do most employees choose a default savings rate of just 3%?’
      Should say employers

    • I disagree and many more will as soon as participants finally will for the first time see just how much fees are eroding their nest eggs. Many assumed their company absorbed these fees and countless think, even on this day, their plans are “free”. Heck many of the company sponsored plans’ “fiduciary benefit committee” lack expertise and transparency. Coupled with the unpredictability and unstable economy I foresee many turning to more conservative options, opting to earn less in return and securing a next egg that doesn’t free fall on value every other day. In other words 401k plans have lost their luster Sad to think that such arrangement continue to benefit the chosen few who have relied and will continue to insist on its current shortcomings to guarantee a constant revenue stream for themselves. It’s time you play with your own money and stop wasting mine. I want to retire with dignity.

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  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.