401(k) Plans: Boosting Participation and Participant Contributions

For many workers today, 401(k) plans are their primary retirement savings vehicle. Are American workers making the most of their 401(k) plans? Unfortunately, most of them are not. One-quarter of eligible workers choose not to participate in their employer’s 401(k) plan, and, of those who do participate, less than 10 percent contribute the maximum.¹ There clearly is plenty of room for improvement, in terms of both participation and contributions.

Recent research by Watson Wyatt examined the ways in which communication can boost employee 401(k) participation and contributions. The study report, “The Importance of Financial Communication for Participation Rates and Contribution Levels in 401(k) Plans,” corroborates findings from earlier studies: Enhanced financial communication goes a long way in convincing employees to sign on to the 401(k) plan and in motivating participants to contribute to the plan. In fact, to stimulate employees to participate and contribute more, improving financial communication can be just as effective as raising the match rate — and sometimes may be more effective.

The evidence suggests that employers can increase both participation and contribution rates by making financial education materials and retirement income projections more widely available. The communication methods are also important. More sophisticated, web-based communication programs tend to result in greater enrollment and savings rates than other forms of communication.

This article examines the ways in which employee and plan characteristics and communication programs influence employees’ 401(k) plan participation and savings behavior. The study employs multivariate regression models to estimate (1) the probability that an employee will participate in the plan, and (2) the factors that influence participants’ saving rates.

Communication programs are scored as being either low, average or above-average. These scores are based on survey responses regarding the scope of plan information, educational materials and projection information provided. The scores also reflect how often the materials are distributed and whether they are available online.

The results indicate that the typical communication program regularly provides personalized 401(k) contribution and loan information, 401(k) account balances by fund and information on the historical performances of funds. Slightly less common is educational material about issues such as the importance of participating in the plan, the time value of money and income needs in retirement. Many employers give workers total income projections and/or provide access to some modeling and projection tools. In recent years, employers have increasingly offered 401(k) services and information via the Internet. The average communication program includes an equal mix of online and paper-based materials. Companies that are more web-oriented offer two-thirds of their 401(k) communication services via the Internet, while those less web-based are at about 30 percent.

The study found that employees who are older, earn more and have longer periods of service are more likely to participate in the 401(k) plan and to contribute a higher percentage of their salary than younger employees who earn less. Having a defined benefit plan reduces the likelihood of an average worker’s 401(k) plan participation by 10 percent. The typical male is 7 percent less likely than his female counterpart to participate in the plan.

Factors Affecting Participation

Financial communication — projections and education — and web-intensity have a statistically significant effect on employees’ 401(k) plan participation. Figures 1 through 4 project the effects of communication on workers’ participation and contribution decisions. The figures pertain to a hypothetical 40-year-old male earning $40,000 a year who has five years of service. He works for a non-manufacturing company with 10,000 employees. In Figures 1 and 2, the employer’s match rate is $.50 on the first 6 percent of pay. The company also provides a defined benefit plan.

In a firm with a 401(k) plan and a very basic financial communication program, the model projects plan enrollment at 62 percent. By enhancing its financial education program up to an average level, the company can raise participation rates to 67 percent. Providing access to retirement income projections similar to those offered at the average firm boosts participation rates up to 69 percent.

Notes: Fitted probability for a 40-year-old male earning $40,000 a year who has five years of service and is covered by a defined benefit plan. He works for a non-manufacturing company with 10,000 employees that provides a company match rate of $.50 on the first 6 percent of pay. “Low Communication” is a two standard deviation decrease from the average level of communication, which is represented by “Education, Projections & Web.” “High Communication” represents a two standard deviation increase from the average level of communication.

Source: Watson Wyatt Worldwide.

Financial education and retirement income projections combined, delivered with an average level of web-intensity, raise participation to an average of 74 percent — a gain of 12 percentage points. Companies that provide significantly more comprehensive financial communication than that offered by the average employer achieve participation rates of 84 percent.

Plan design also affects employees’ savings decisions. One component of the design is the percentage of the first dollar of an employee’s pay that the employer matches, i.e., the match rate. The second component, which often was overlooked in previous studies, entails the maximum percentage of an employee’s pay (or dollar amount) up to which employers contribute, i.e., the match threshold.

Increasing the first-dollar match rate from 25 to 50 percent increases average participation by roughly 8 percentage points. Workers are 15 percent more likely to participate in a plan with a 75 percent match than in a plan with a 25 percent match. If the employer offers a 100 percent match, workers are almost 20 percentage points more likely to participate.

Figure 2 shows the changes in estimated participation rates as workers get older, in companies with below-average, average and above-average communication programs. The probability of a worker participating in the plan rises rather steeply up to about age 29. At ages 30 to 57, participation rates remain moderately flat. As workers approach retirement, however, participation rates drop off. In fact, participation rates for workers aged 21 to 29 roughly mirror those for workers aged 57 to 65. Again, we see that enhanced financial communication is associated with a higher likelihood of enrollment in the 401(k) plan.

Notes: Fitted probability for a male worker earning $40K a year who has five years of service and is covered by a defined benefit plan. He works for a non-manufacturing company with 10,000 employees that provides a company match rate of $.50 on the first 6 percent of pay. Low communication is two standard deviations below the average level of communication. High communication represents two standard deviations above the average.

Source: Watson Wyatt Worldwide.

Financial communication has significant effects on all workers, but particularly on those at low earnings levels. For employees earning $20,000 in companies with average financial communication programs, participation rates are 50 percent. For those who are exposed to the same financial communication but who earn $60,000, participation rates are over 85 percent. Enrollment rates level off for those earning more than $70,000 and remain relatively constant for all earners at higher levels.

In Figure 3, the lowest profile shows the estimated participation rates for a company that offers a 25 percent match rate with a 6 percent match threshold and has a below-average financial communication program. For a worker earning $40,000, either raising the match rate to 100 percent or improving the financial communication program would achieve the same effect: raising participation rates from 52 to 78 percent. However, the impact would be much less dramatic for a worker with annual earnings of $100,000.

Notes: Fitted probability for a 40-year-old male worker who has five years of service and is covered by a defined benefit plan. He works for a non-manufacturing company with 10,000 employees. Low communication is two standard deviations below the average level of communication. High communication represents two standard deviations above the average.

Source: Watson Wyatt Worldwide.

Factors Affecting Contributions

For the average worker at a firm with a below-average financial communication program, the model projects an estimated average 401(k) plan contribution of 5.5 percent of annual salary. Providing an above-average level of retirement income projection tools can increase savings rates by 0.4 percentage points. Providing employees with immediate, hands-on access to financial materials and their own account information can boost savings rates by 0.8 percentage points. And bringing lower-than-average financial communication up to an average level can boost 401(k) plan retirement savings from 5.5 to 6.9 percent. Improving the financial communication program to above average would raise the average savings rate to a healthy 8.2 percent.

Individual workers’ characteristics affect contribution rates as well as participation rates. Both age and wages have a positive and significant effect on 401(k) savings rates. Workers’ contribution rates steadily increase as their earnings rise, up to approximately $80,000, after which they decline precipitously. The decline in saving rates for higher-wage earners is undoubtedly due to the IRS contribution limits and the fact that some companies impose contribution limits on high-wage workers because of actual deferral percentage tests.

Female workers tend to contribute a higher percentage of their salary to the plan. Although the presence of a defined benefit plan lowers 401(k) participation rates, it raises participant contributions by 1.1 percentage points. Employees of large companies tend to contribute a slightly larger share of their salary than their counterparts at small companies. Employees working in the manufacturing sector generally contribute less than workers in the service sector, which may partly reflect the more generous defined benefit pension plans in the manufacturing industry.

A rise in the match rate has a negative effect on contribution rates, while an increase in the match threshold has a positive effect. Changes in both the match rate and match threshold largely offset each other. As Figure 4 illustrates, improving the financial communication program can increase contribution rates more than raising the match rate and the match threshold can.

For example, consider an employee at a company that offers a 401(k) plan with a 50 percent match on the first 3 percent of pay. Assume this company has a below-average communication program. Under this scenario, the typical worker earning $40,000 would contribute roughly 5.2 percent of his annual salary to the 401(k) plan. To encourage higher 401(k) savings, the employer would want to raise its match threshold, rather than its match rate. For example, raising the match threshold to 8 percent while holding the match rate at 50 percent would raise the contribution rate to 5.7 percent for this average worker. Alternatively, increasing the match rate to 100 percent on the first 3 percent of pay would likely cause this worker’s contribution rate to decline to 4.7 percent.

Enhancing the financial communication program would provide the biggest boost to employee contributions. In the scenario described above, enhancing the financial communication program while offering the same match rate would increase average contribution rates from 5.2 to 6.5 percent — more than double the predicted effect of a 5 percent increase in the match threshold.

Notes: Fitted estimates for a 40-year-old male worker who has five years of service and is covered by a defined benefit plan. He works for a non-manufacturing company with 10,000 employees. Low communication is two standard deviations below the average level of communication. High communication represents two standard deviations above the average.

Source: Watson Wyatt Worldwide.

Summary

An enhanced financial communication program is an effective means of raising 401(k) participation and contribution rates. The biggest boost comes from the use of web-based tools, which enable employees to access their account information, projection software and educational materials on their own time and at their own pace. Providing retirement income projections and financial education materials also raises participation and contribution rates — although the effects of those efforts are somewhat less significant.

These findings have important implications for employers, especially those that are concerned about their employees’ savings behavior and those that need to raise participation and contribution rates to comply with IRS regulations. Generally, enhancing a financial communication program can boost employee enrollment as much as sweetening the company match rate can. In encouraging employees to save more, improving financial communication may be more effective than increasing the company match. Organizations should therefore consider both alternatives when attempting to promote employee interest in their 401(k) plans. Enhancing the financial communication program may be both cheaper and more effective than making costly adjustments to the match rate.

About the Data

Watson Wyatt collected the data for this analysis from a combination of personalized benefits statement records and actual deferral percentage testing files for the period between October 2000 and March 2001. The 401(k) plans in the data set are offered by 48 firms, ranging in size from 335 to more than 41,000 employees. The data set includes 306,463 employees, roughly 30 percent of whom are employed in the manufacturing industry. We collected information on the financial communication programs via a questionnaire that was completed by a human resource representative at each firm. Of the 48 plans for which detailed administration data was available, we collected responses to the communication questionnaire from 26 firms. All employers in the sample provide personalized statements to employees.