Defined Contributions Insights MagazineMay/June 2008
The Savings Escalator
There was an automatic in 401(k) before there was automatic enrollment.
by David W. Wray
The 401(k) system is increasingly successful on many levels. As Chart 1 shows, the total dollar contribution to employer-sponsored defined contribution plans has increased every year for which the Department of Labor has data. In 1975, the total contributed was $12.8 billion. $248.8 billion was contributed in 2005. This result is all the more remarkable because this 30-year period includes recessions as well as good times. There are many reasons for this outcome. For example, the growth in the number of plans and participants is well-recognized. However, there have been intervals during this period when the number of plans and participants did not increase. Why then did the contributions increase?
I believe it’s because the system has a built-in savings escalator. The government’s regulatory regimen is based primarily on the identification and testing of percentages. For example, to remain qualified, a plan must have a certain percentage of those over age 21 with one year of service eligible to participate. Also, comparisons of highly-compensated and non-highly compensated participant savings behavior are expressed in percentages. As a consequence, systems supporting 401(k) plans require that employer and employee contributions to these programs be identified as percentages of participant pay.
In practice, this results in employee contributions automatically escalating along with increases in pay. Not only has this resulted in a continued increase in overall contributions in the system, it has increased the average total of employee and employer contributions per active participant as demonstrated in Chart 2. In 1975 the average contribution per active defined contribution participant was $1,112. It was $4,612 in 2005, and I believe the average total employer and employee contribution today is approaching $5,000.
This was not always the case. I can remember when it was common for a profit sharing contribution to be dollar denominated and there still are plans where the match is based not on a percentage of pay but on employee dollars contributed, but the practice is unusual. The need to comply efficiently with Federal regulation has had the unintended effect of building a savings escalator into the system before automatic enrollment was even considered. The U.S. 401(k) system is amazing in its ability to help workers build retirement wealth. This is another reason why.
David Wray is PSCA’s president.
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