Automatic 401(k) plans still require
Sometimes you have to be pushed
into doing something that's good for you, such as investing in your
company's 401(k) plan.
Employees frequently have a lot of excuses for not
enrolling in their company's 401(k) program. Some people are spread
too thin -- too many bills, not enough money. Others think they're
too young to worry about saving for retirement. And then there are
employees who just don't care.
That's why some companies have started 401(k) plans
in which employees are automatically enrolled unless they specifically
choose to opt out.
Studies have demonstrated that the approach leads
to far greater participation in the programs.
Pushing people to save
However, experts say, many of the employees need another push.
The employees aren't making the best of the situation; and most
of the companies aren't doing anything about it.
The problem is that most automatically enrolled employees
stay with the contribution rate and investment options selected
by the company, called defaults, rather than increasing their contributions
and taking on more risk to get a better return on their investment.
These defaults are deliberately ultraconservative, and usually not
the best choices for a long-term investor.
A recent study showed that even after three years,
half the employees who had been automatically enrolled continued
to contribute at the default rate and put their money in the default
Long-term participation in a 401(k) plan is the best
opportunity most people have for ensuring they have enough money
to last what could be 30 years of retirement. There may be no faster
way to build a nest egg, thanks to tax-deferred savings and, in
most cases, an employer match.
But investing minimal amounts in money market funds,
as default selections often do, won't build your retirement fund
Most companies set the so-called default contribution
rate for automatically enrolled employees at a fairly low amount
such as 3 percent. The default investment option is usually something
very conservative such as a money market fund.
"The last thing an employer wants to do is take
$20 out of someone's paycheck and the employee looks at their statement
and sees their investment is down to $19," says Steve Utkus
of Vanguard's Center for Retirement Research.
But Brigitte Madrian, associate professor of economics
at the University of Chicago and co-author of the 401(k) study,
says companies need to do more than just automatically enroll employees.
"The big problem is 401(k) plans are designed
with the assumption that people want to take charge of their retirement
savings. Some people want others to make the difficult decisions
for them. The plans don't work for those employees.
"Companies need to think about ways to structure
their plans so they help employees who don't want to take charge.
Investing is complicated. A significant portion of the population
doesn't understand which investments are less risky and which are
About 15 percent of the 1500 companies that use Vanguard
to manage their 401(k) plans have automatic enrollment.
Education and encouragement
Utkus says there are two solutions. One, an ongoing educational
campaign directed at people in the default rates and investment
options, takes time and energy on the part of the employer.
"It's a lengthy and time-consuming process. The
employer has to commit to doing it over many years. It's a perpetual
problem as new employees come on.
"The other option is on the savings side. Allow
participants to automatically have their contribution rate go up
by 1 percent every year. It's the "save more tomorrow"
concept. You set up a savings plan designed to step up savings over
time. We've tested it with a client and we're rolling it out to
others," says Utkus.
Utkus also suggests companies choose a different investment
default: a balanced fund or lifestyle fund that includes stocks,
bonds and money markets, and adjusts the risk allocation based on
the age of the participant.
Convenience store giant 7-Eleven automatically enrolls
employees on their one-year anniversaries into what amounts to a
portfolio of stocks, company real estate and other investments.
"We don't have financial education because employees
don't have investment discretion," says benefits manager Margaret
Fuller. "But we send them a reminder 45 days before their first
"There's a bar chart that shows their projected
balance over a period. We also take their last pay check
stub and reproduce it to show the actual change to their net pay,
because a lot of people hear 3 percent and think more comes out
of their take-home than really does."
7-Eleven employees can opt out of the program or they
can elect to contribute up to 6 percent of their gross pay. Employees
who do nothing are automatically enrolled at 3 percent.
Fuller says the company started automatic enrollment
in 1997 and the participation rate in the 401(k) is 72 percent,
up from 57 percent prior to automatic enrollment.
While increased participation benefits a company's 401(k) plan
in many ways -- it helps the company meet nondiscrimination tests,
for example -- employers are also concerned about the cost of automatic
"They say, 'What do I do if I end up with all
these accounts with 3 percent in them,'" says Utkus. "You
create all these accounts, go to a vendor and pay fees on them.
There are higher administration fees to pay for all these small
There's also a question as to whether companies put
themselves at risk if the default investment option loses a significant
amount of the employees' money.
"Employers perceive there to be a liability risk,
but it's more imagined than real," according to Utkus. "But
it's the frivolous lawsuit that worries them."
Ironically, it's believed that while automatic enrollment
gets more people into the plan, it may actually hurt some employees
in the long run financially.
"If the company chooses a lousy default, it works
against employees who might have gotten their act together and chosen
a better option down the line," says Madrian.
"The vast majority of employees who enroll in
a 401(k) choose a contribution rate equal to the company match or
higher. If an employee isn't automatically enrolled, it might take
them longer to get signed up, but they'd probably pick a higher
contribution rate and a more aggressive allocation."
The best thing would be for more employees to become
active participants in managing their 401(k). That's a viable option
for some workers but not for all, according to Vanguard's Utkus.
"Only about half of the population in a retirement
plan has all the characteristics you want -- forward thinking, confident
about making decisions and actively interested in managing their
money. We're coming to realize that there isn't a single target
participant. There should be an option for the participant who makes
few decisions, if any. That choice doesn't exist today."
Utkus says he doesn't expect a lot of companies to
join the automatic enrollment bandwagon until the economy turns
around. Employers who have been battered by the rough economy don't
want to be responsible for additional matching contributions.