Don’t Let 401(k) Auto-Enrollment Decide Your Contribution Rate For You

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The Wall Street Journal has a rather surprising article 401(k) Law Suppresses Saving for Retirement regarding a recent law that allowed employers to automatically enroll their employees into their 401(k) retirement plans. The goal was to encourage saving and make contributing a certain percentage rate the default option for workers, after which they could change the contribution rate to whatever they wanted (even zero). Before now, the default option was usually little more than passing out a brochure.

Auto-enrollment seemed like it was working. More workers than before were using 401(k) plans. The problem was, the default percentage rate for most plans was about 3%. It turns out that for some people that 3% is actually less than the 5-10% than people might have chosen on their own if started from zero. As a result, the study showed that 40% of workers ended up actually saving less after auto-enrollment began. Talk about unintended consequences!

Source: WSJ (Click to enlarge)

Possible reasons include inertia (aka laziness), but I suspect that if a company sets it at a certain percentage, then there can be a subconscious belief that such a number is the “recommended” or “approved” contribution rate. In reality, that 3% appears to be chosen simply to be low enough as to avoid workers opting-out immediately. In other words, much lower than what would be required to fund a proper retirement.

The study noted was done by the Employee Benefit Research Institute, which actually wrote a rebuttal article that focused on the fact that auto-enrollment is increasing the savings rate for many people, especially those with lower incomes. The problem is not with auto-enrollment itself, but more with tinkering with the default contribution rate. Another potential tool is an “auto-escalation” feature that increases employee savings rates by a set amount each year, say 1%, to encourage more savings over time.

When it comes down to it, the study pretty much reaffirms the original conclusion that started auto-enrollment in the first place. Lots of people are too busy, forgetful, uneducated, or scared to make the proper financial decisions for themselves. Don’t rely on your employer to decide how much to save for retirement.

Everyone has a different situation, but if you don’t have a pension or other significant retirement assets, your overall savings rate is probably going to have to be more than 10% if you expect to replace most of your income upon retirement. The tax advantage of traditional and Roth 401ks is very significant over time. Finally, if you have an employer match available, don’t say no to free money!

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  1. If I remember correctly, the 3% was chosen to get the most out of the employer match across the board.

  2. I bet employers aren’t complaining about the 3%–the higher the percentage, the more they have to match.

  3. Isn’t it obvious that if auto-enrollment increases number of participants, but these new participants never bother to increase their contribution rate, then the average savings rate will fall?

  4. could it also be that the market over this period of time has scared these people away. The market was very turbulent from 06-11 and it would not surprise me if people were hesitant to increase thier contributions.

  5. 401k is a big thing, new grads/immigrants do not belive in this kind of saving until they read/talk/educate about this over some time, which is generally too late(couple of years), same in my case . When I started working there was not even 3% default cut, so I lost 401k contribution/match for couple of year until I learnt about this. With stock market going in swings day-in-day out, new entries are scared to set aside their money to invest in something they know its a kind of a gamble of their hard earned money. I think WSJ article is in right direction, but employers should educate on this very early and some hands on examples should help .

  6. Jenna, Adaptu Community Manager says

    I still think 3% is better than nothing.

  7. I agree with the poster and the market turbulence potentially affecting employee’s decisions about how much to contribute to a 401k. Other potential issues could be:

    1. Declining salaries leading to workers choosing to contribute less.
    2. smaller employee match leading to less 401k contributions vs. other retirement (IRA, etc.) savings options.

  8. DC Provider says

    I work with many plan sponsors and only about 10% use auto-enroll. They usually try to coincide it with the employer match. Employees are victims of their own inertia (put plainly it’s stupidity masked as disinterest masked as being uneducated). What is so hard about ‘save as much as you can as early as you can.’ The plans that do offer auto-enroll see about a 30% opt-out rate, but another % of the employees do not realize they want to turn it off until after the opt-out period which is then when the first contribution is deducted from their paycheck (usually 45 days). The bottom line is that blue collar workers cry foul (this stuff is too complicated, they can’t afford it, blah-blah-blah), but they need to take some responsibility for their own retirement.

  9. I think the auto-escalation feature is a great idea.

    Perhaps they should make 3% contribution with auto-escalation of 1% a year the default option.

    If the employees notice that it has too great of an effect on their paycheck, they can make their own changes.

  10. I hate how restrictive these plans are. I wish I could select exactly how much I wanted to contribute to the 401(k) at any given time. It shouldn’t take 2 pay periods for the change to go through. I work varying amounts of overtime and my paychecks thus vary greatly. If I am going to max out my 401(k), I have to time it exactly right so that I’ll hit the limit on the last check of the year, in order to not forgo any employer match.

    Also, why don’t they just let us invest it anything we want? Why do they have to make certain funds available and restrict people from investing in ETFs, stocks, bonds, gold, real estate, or whatever? Can I just simply hold a portion of savings in cash in my 401(k) if I choose to do this for a period of time?

  11. I think auto enrollment is a great idea– the company where I work, which is sizable mind you, does NOT have auto enrollment. In fact, I believe only 45% of the employees take advantage of our 401k plan, which is always shocking to me. I think many are confused about the 401k, myself included when I first enrolled, but in the more recent years, our company has sponsered free classes on the 401k, which are unfortunately not well attended.

    For me, what opened my eyes, were some articles I came across on the internet about 401k, and I realized I was WAY under contributing. We DO have a company match, which is 6%, but at the time I never realized I should contribute more. I didn’t have a plan, and I didn’t know what investments to choose. Today it’s a lot better than when I started in the plan though. There’s tools for forecasting. There’s even a feature to auto choose your investments based on an investment style and age to retirement. Yet, still, no auto enrollment…

  12. Hi All.

    I have a few thoughts on this post.

    1. Employers should never auto enroll. Re allocating a person’s income without their consent should be illegal. I’m glad congress is addressing this issue. With that said, 401ks are great IMO. I think employers should work more on educating employees about the benefits of 401ks.

    2. The decrease in the savings rate seems pretty negligible in the last graph. There are many factors involved. Many people living paycheck to paycheck might need to sacrifice the long term for the short term gain. With the economy still under water, I think it’s natural for some folks to draw back on contributions. With many employers freezing salaries and putting a stop to matching contributions between ’07-now, it’s no surprise contributions went down. I’m surprised the drop wasn’t larger.

  13. I agree that the decrease in savings seems negligible, but championing “more education” isn’t in any way effective — how many people know smoking or obesity are bad, yet continue to choose unhealthy behaviors? Educating people doesn’t intrinsically solve their problems.

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