What is the 401k Average Deferral Rate?
(Part two of a four part series.)
When it comes to deferral percentages, the most asked question is: “What does everyone else do?” It shouldn’t surprise you to find out the answer ranges all across the board. In their “Annual 401(k) Benchmarking Survey (2012 Edition),” Deloitte found “the most common default deferral percentage remained consistent from 2011 to 2012 at 3%. While a 3% deferral rate will get participants into the plan, unless it is coupled with step-up contributions and an active education campaign, 3% is not likely to support a comfortable retirement.” On the other hand, Russell Investments (“A Defined Contribution Retirement Handbook – 2014/2015”), citing Plan Sponsor Council of America’s “55th Annual Survey of Profit Sharing and 401k Plans, 2012,” reports an average contribution rate of 6-7%.
Academic studies (see “7 Low or No-Cost Ways to Increase 401k Participation,” FiduciaryNews.com, July 17, 2012) have long suggested why participants aggregate deferral rates around certain percentages and real-world practitioners can confirm their findings. It’s called the “matching threshold” and it means people will contribute up to the percentage of the company match. Joshua Duvall, a financial planner for Capital Financial Services in Glenville, New York says, “The typical deferral rate is unfortunately only as high as the company match. For example, many employers match employee contributions into a 401k at a limit of 5%. So the employee will contribute 5% of their salary to a 401k to make sure they get the full 5% match from the employer but they won’t go higher than that. From the employees viewpoint, they don’t want to leave ‘free money’ on the table, but they also feel like they have to live and can’t be determined enough to decrease their standard of living so they can contribute more to their retirement account. It is a constant struggle for most American employees.”
Courtenay Shipley, Chief Planologist at Retirement Planology, Inc. of Alexandria, Virginia offer this explanation as to why employees defer whatever the match rate is and no higher. She says, “There’s a mentality that the company match is the ‘max’ they should put in.” She also notes, sans match, the deferral rate is much lower. If there is no match, she says the average deferral rate is “somewhere around 4% with lousy overall participation. That is usually caused by 1 or 2 people putting a lot in and a whole lot of folks not participating at all.” The problem, as she sees it, is with the very nature of the “deferral rate” itself. It’s not a hard dollar amount. Rather, it only reflects a percentage of someone’s paycheck. “Overall, percentage rates are tricky,” says Shipley. “Most people don’t know or calculate out what 1 or 2% of their check is. I think there’s a bit of a misconception that it’s a lot of money.”
Still, the matching threshold remains the primary factor in determining deferral rates. “The most common amount I see is the match. For example if the match is 50% of the first 4%. I see the average contribution around 4%,” says Andrew Carrillo, President of Barnett Capital Advisors in Miami, Florida.
Kevin Hall, President of BenePAY Florida, located in Clearwater, Florida, sees the most common deferral rates ranging “between 3% and 6%.” He says, “The employers matching formula directly relates to the amount employees defer to maximize the match.”
Echoing Hall, Christa Reddy, President of Pro-Plans, Inc. in Pompton Lakes, New Jersey, says, “In our business the typical deferral percentage we see is 5% to 6%. While there are some employees who defer more, many defer only so much as to receive the maximum employer matching contribution. Many employers match deferrals up to 6% of compensation.”
Besides the “matching threshold,” academics have discovered that people also set deferral rates around arbitrary numbers – normally numbers divided by 5. For example, Darryl J. Poisson, founder and president of DJP Wealth Management in Tampa, Florida says, “I most typically see employees defer the exact same percentage as their employer matches independent of the size (2%, 6%, etc.) of the match. Outside of this phenomenon, I most commonly see deferral rates of 5% and 10%. Anecdotally, these deferral percentages lead me to believe that participants are making elections optically (10% is a nice round number) rather than consciously attempting to target their future needs.”
Professors and professionals agree on what drives participants to select their deferral rate. So, we know why people tend to pick the amount they contribute. We also know what the average deferral rates are. But the average is often not the ideal. What is the ideal deferral rate? We answer that question in the next section of this series.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada. His forthcoming book Hey! What’s My Number features his usual whimsical dialogue in a face-to-face talk with a plan participant mixed with the combined wisdom of the financial professionals he’s interviewed over the years. Be sure to subscribe to FiduciaryNews.com so you can be to the first to hear when this book is available to the public.