How has the Pension Protection Act enhanced workers’ retirement security?
VALLEY FORGE, Pa., June 8, 2016 /PRNewswire/ — This summer marks the 10th anniversary of the Pension Protection Act of 2006 (PPA)—landmark legislation designed to enhance workers’ retirement security—being passed into law.
Coinciding with this milestone, Vanguard today released a special 15th anniversary edition of its How America Saves report with findings that reflect the impact of the law on improving plan construction and participant investing behaviors in defined contribution plans over the past decade.
How America Saves, Vanguard’s comprehensive annual defined contribution report, has become a premier source of 401(k) data and serves as a resource to Vanguard plan sponsor clients and the industry at large as a plan benchmarking tool. First published in 2000, the report is based on 1,900 plans and 3.9 million participants.
“The Pension Protection Act codified many of the ‘auto pilot’ features that Vanguard and others in the industry had been advocating for in retirement plans for years,” said Martha King, managing director of Vanguard’s Institutional Investor Group. “The improvements brought on by the industry, amplified by the PPA, has continued to bolster our defined contribution system and cements our view that 401(k) plans are a critical component to helping ensure the retirement security of millions of Americans.”
Maximizing participation and boosting savings rates
Among its provisions, the PPA enabled the automatic enrollment of workers into 401(k) plans at a default savings contribution rate, as well as the auto escalation of workers’ contribution rates on a periodic basis.
As of year-end 2015, 41% of Vanguard plans had adopted automatic enrollment, up from just 10% of plans a decade ago. Of those plans, 70% featured automatic annual increases. Last year, 63% of new Vanguard participants were hired under automatic enrollment, versus 12% in 2006.
Vanguard research has shown that automatic enrollment can more than double participation rates in comparison to voluntary enrollment plans. This trend is particularly evident among young or low-wage workers, who tend to exhibit lower savings behaviors. In large part due to autopilot design features, aggregate participation rates are higher than ever and continue to rise. In 2015, three-quarters of eligible employees participated in their employer’s plan, up from two-thirds ten years ago.
Driving prudent investments
The PPA also sanctioned the use of target-date funds as a qualified default investment alternative. Vanguard researchers have long espoused the merits of target-date funds and other professionally managed options, maintaining that they can result in more prudent and risk appropriate participant portfolios.
Target-date fund use has nearly doubled since the passage of the PPA, with 90% Vanguard plan sponsors offering target-date funds at year end 2015. In aggregate, 98% of participants now have access and 70% of participants use target-date funds.
According to Morningstar, Vanguard leads the industry in target-date assets and net cash flow, in large part due to defined contribution plan allocations.1 Last year, more than $4.60 of every $10 contributed to Vanguard plans were directed to target-date funds. Earlier this year, Vanguard also reported expense ratio reductions for twelve of its Target Retirement Funds.
“Target-date funds are, without question, a game changer and one of the most important elements of the 401(k) evolution,” said Jean Young, lead author of How America Saves. “As defined contribution plans evolved, it was clear that many workers were not going to serve as their own investment manager. As a result of the rise of target-date funds, we’ve seen dramatic improvements in the portfolio construction of 401(k) participants.”
There’s work to be done
Looking ahead to the next decade of the post-PPA era, How America Saves data points to key areas needing improvement.
In particular, the rise of automatic enrollment has had an inverse effect on deferral rates. Nearly three-quarters of plans default at participant at savings rates of 4% or less. Automatic enrollment boosts participation rates, but it can lead to lower contribution rates when default deferral rates are set at insufficient levels. In contrast, Vanguard recommends a target savings rate of 12%–15%, including an employer match.
“Plan sponsors—and the industry as a whole—must bear the responsibility to continue the significant progress impelled by the PPA, including driving improved savings rates for all participants,” said Ms. King. “Moreover, the 401(k) system needs to cast a wider net to afford the opportunity for more Americans to prepare financially for retirement and capitalize on the advantages of these plans.”
Vanguard: A DC Plan Leader
Vanguard is a leader in the DC marketplace with more than $800 billion in defined contribution assets under management as of March 31, 2016. In our defined contribution recordkeeping business, Vanguard serves more than 5,900 plan sponsors and more than 4.1 million participants.
Investments in Vanguard Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.
Vanguard is one of the world’s largest investment management companies. As of May 31, 2016, Vanguard managed more than $3.5 trillion in global assets. The firm, headquartered in Valley Forge, Pennsylvania, offers more than 325 funds to its more than 20 million investors worldwide. For more information, visit vanguard.com.
All figures as of May 31, 2016, unless otherwise noted.
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1 Source: Morningstar, Vanguard