Rethinking 401(k) Plan Success: The power of deferral rates

By Jerry Kalish on March 17, 2023

From the beginning of 401(k) plans, the retirement industry has focused on the performance of individual funds as the key driver of retirement readiness. But a study by the Putnam Institute in 2006 and repeated in 2012 concluded that increasing deferral rates have the greatest potential impact on a 401(k) participant’s account balance at retirement

The Putnam Study, Defined Contribution Plans: Missing The Forest For The Trees?, showed that fund selection was actually the least important factor compared to asset allocation, account rebalancing, and increased deferrals. The most important? Increasing deferral rates.

Putnam arrived at this conclusion by simulating different portfolios of mutual funds in a hypothetical, but typical, 401(k) plan. Here is how the study can be viewed from a plan sponsor’s perspective:

Plan Activity	Time Spent	Relative Importance
Selecting Funds	Most	Least
Allocating Assets	More	Lesser
Rebalancing Accounts	Lesser	More
Increasing Deferral Rates	Least	Most

One way – maybe the best way – to increase deferral rates is through auto-enrollment and auto-escalation. Congress thinks so. As part of the recently passed SECURE 2.0 employees are automatically enrolled in a 401(k) plan at 3% of compensation. The amount is increased each year by 1% up to at least 10% but not more than 15% of the employee’s compensation. There’s a plus for the employer: tax credits may be available.

Photo by Dino Reichmuth on Unsplash