One of the most promising aspects of retirement saving policy in recent years is the advent of “automatic” or opt-out features in 401(k) plans. Automatic 401(k)s enable saving even if the worker makes no effort to participate in their 401(k) plan. In a 401(k) plan without automatic features, workers have to actively choose whether or not to sign up for the plan, how much to contribute to the plan and the investment allocation for their assets (see Gale, Iwry, Orszag 2005 for additional background). These decisions can be complex and daunting. As a result, busy people often procrastinate or are unable to decide the best way to proceed; the result of such inaction is that these workers do not participate in their 401(k) plan or they make imprudent investment choices. By contrast, in a 401(k) with automatic enrollment, workers are automatically enrolled in their employer’s plan at a default contribution rate, and funds are directed into balanced, prudently diversified investment accounts, unless participants affirmatively choose otherwise. Therefore, those who are unwilling or unable to make these complicated decisions would be saving through automatic 401(k)s.
Automatic 401(k) plans are beneficial to workers on several levels. First, they start workers on a saving path earlier than they otherwise would. With automatic enrollment, participation in 401(k)s increased
from 75 percent to as high as 90 or 95 percent of newly eligible employees (Madrian and Shea 2001); the change was highest among lower-income and minority workers. Second, workers will generally be
invested in more appropriate and diversified funds in automatic 401(k)s than if they invest on their own. Third, contributions to 401(k) plans are generally tax-preferred relative to saving outside of 401(k)s because contributions to 401(k)s are tax deductible.
This paper provides estimates of the effects – on federal revenue and the distribution of after-tax income – of a policy under which all 401(k) plans in the U.S. were converted to automatic 401(k)s. In recent years auto 401(k)s have become more prevalent, in part due to the passage of the Pension Protection Act (PPA) of 2006, which provided new incentives for automatic 401(k) plans and addressed several employer concerns regarding automatic 401(k)s. Between
2006 and 2007, the number of employers offering automatic enrollment
increased from 26 percent to 44 percent among surveyed employers.4 The paper should play an important role in helping policymakers, analysts, and pension administrators evaluate the merits of automatic 401(k)s.
Due to the preferred tax treatment of 401(k) contributions, federal income tax revenues are expected to decline with the increase in 401(k) participation – generated through higher enrollment rates and higher contribution rates. In addition, automatic 401(k)s will differentially impact workers at different income levels. Workers with higher marginal tax rates will receive a larger reduction in tax when they contribute to 401(k)s than workers with lower marginal tax rates.
On the other hand, in practice, automatic features in 401(k)s disproportionately increase enrollment for workers with lower-income, who face lower marginal tax rates. Furthermore, the default contribution rates were, for some workers, lower than what they may have chosen in the absence of automatic features, which lower both their level of tax benefit and the revenue loss.
We find the revenue costs to be modest over the ten-year budget window, particularly in relation to the revenue cost of providing saving incentives through employer-sponsored retirement saving plans. The revenue loss from making automatic enrollment in 401(k)s universal and implementing a default contribution rate is between $3.5 billion and $6.9 billion per year, and with losses between $35 billion and $69 billion over fiscal years 2008-17. The higher revenue estimates are associated with a model that includes the escalation of the
default contribution rate over time.
We find that the distributional effects of making automatic enrollment in 401(k)s universal and implementing a default contribution rate are progressive relative to the current system. Specifically, we find the proportion of the benefit going to taxpayers in the bottom four income quintiles – taxpayers in the bottom 80 percent range of the income distribution – is larger than their share of the overall tax burden.
Section I describes the Automatic 401(k) proposal. Our modeling procedure is described in Section II. Section III presents and discusses the central results. Section IV concludes.