The Problem with 401(k) Auto-Enrollment
A good effort has been made by companies to get more people to invest in 401(k) plans. One feature that has worked to boost participation is, of course, the auto-enrollment feature that accompanies 401(k) plans. This is both a convenient and effective method for accumulating retirement savings, since a percentage of the employee’s pay is automatically deducted pre-taxed, and then placed in a select investment vehicle. Plans offering automatic enrollment have an employee participation rate of 82 percent, compared to 65 percent participation in plans where funds are voluntarily applied.1
However, are such increases sufficient?
There are several problems that arise from auto enrollment. The majority of employees who use auto enrollment do so at the default rate, which is 3 percent of their pay, which was set by the passing of the Pension Protection Act of 2006. It has been argued however, that 3 percent is an insufficient amount to provide for a comfortable retirement. There has been a push to increase the default rate to 6 percent, which would increase the success rate of retirement savings for both low- and high-income workers.2
Some employees choose to voluntarily increase their contributions to the more sensible 6 percent or more, but those who do so are very few. There remains a problem even in this scenario, because when these employees change jobs, they must remember to increase their withdrawn amounts with their new employer. If they fail to do so, their contributions are automatically reset to the default amount of 3 percent. Such individuals may go quite a while before noticing their deductions have dropped, which can adversely affect their planned retirement figures.
Automatic deferral rate escalation is another option that is provided to employees with 401(k) plans, which can increase contributions by 1 percent annually as well as when employees get pay raises. However, only 40 percent of all auto-enrollment plans offer auto-deferral rate escalation. Although automatic escalation helps to ease the pain of retirement savings by automatically deducting set amounts from employee paychecks, and the trend is growing in popularity, there are still relatively few employees that utilize the feature.
So why aren’t there more promising results coming from such attractive retirement savings incentives?
The answer is the same as that of poor results produced in the face of a variety of savings vehicle options — a lack of proper education.
“A good example of this occurred with an auto dealership where I addressed a plan meeting. After an enrollment meeting, a participant pulled me aside and told me that he had built up massive credit card debt with high-interest rates. He asked me if it was better to take a distribution from an abandoned “k” plan to clean up the debt, or carry the debt and save for retirement at a lower level or contribution. This was not a question on taxes or the plan specifically, but one that represented a direct lifestyle issue that was a barrier to him saving in the plan to the level at which he wanted. In this situation, his “k” mentality was downstream due to his biggest concern — his debt, which stemmed from “save a little/spend too much” behavior. The options of his thinking were limited to “cash out, pay off the debt, and start over”, or “carry it and defer smaller amounts.” — Mike Montgomery
There has been a disconnect between the 401(k) industry and employees which has resulted in low participation rates. This disconnect stems from a conversation that focuses on retirement preparedness rather than meeting immediate and pressing financial needs. The solution is to change the conversation to one of financial education and wellness that works to solve current personal financial problems, and boost retirement plan participation rates.
- Friedman, Michael (2013). 401(k) Plan Automatic Enrollment: A Winning Formula. Available from www.buchbinder.com/401k-plan-automatic-enrollment-winning-formula/
- VanDerhei, Jack (September 2012). Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation. Available from papers.ssrn.com/sol3/papers.cfm?abstract_id=2153186
Mark Singer, CFP®, is a seasoned financial planner and the founder of Safe Harbor Retirement Planning, where he has been guiding individuals through retirement planning since 1986. With nearly four decades of experience, Mark has assisted thousands in crafting personalized retirement strategies that align with their unique goals and circumstances.
An accomplished author, Mark has penned several books, including Don’t Outlive Your Money in Retirement! 7 Key Steps, The Changing Landscape of Retirement—What You Don’t Know Could Hurt You, and The New Financial Wellness: Changing the Conversation. These works offer practical insights into retirement planning and financial wellness.
Love this article. “There has been a push to increase the default rate to 6 percent, which would increase the success rate of retirement savings for both low- and high-income workers.2”
So twice that (EE + ER contribution) goes to Social Security, yet those payments will be insufficient to provide a comfortable retirement if solely depending on Social Security for one’s income requirements?
So this is proof of government mismanagement and the failures of Socialism and liberal politics, or the 6% number is wrong.
Which is it?