Automatic 401(k) Enrollment Not A Panacea For Low Savings Rates
Automatically enrolling employees in 401(k) plans is effective in increasing overall participation rates, but many enrolled workers will still fail to save adequately for retirement unless 401(k) sponsors improve default contribution rates and the quality of default investment choices, according to a study by human resources firm Hewitt Associates.
Researchers analyzed the saving and investing habits of 2.6 million U.S. employees. Results showed that 90% of workers at companies with automatic retirement plan enrollment participated in their companies' 401(k) plans, compared with 68% of workers at companies that did not practice automatic enrollment. However, the analysis also indicated that many of the automatically enrolled employees did not actively manage their accounts.
Some 70% of the plan sponsors that practice automatic enrollment had a default contribution rate of 3% or less, the study found. While the average contribution rate of workers who enrolled themselves in the plan was 8%, the average contribution rate of automatically enrolled employees was lower, at 6.8%, according to the analysis. Results further showed that automatically enrolled employees contributed an average of 1.2 times the company match, while voluntary plan participants contributed an average of 1.6 times the company match.
The study also revealed that 42% of 401(k) plan sponsors with automatic enrollment defaulted participants into a stable value or money market fund. Automatically enrolled participants defaulted into stable value funds invested just 31% of their assets in equities, the analysis showed. By contrast, automatically enrolled employees who were defaulted into a target maturity or balanced fund invested 67% of their assets in equities—the same percentage as participants who voluntarily signed up for the plan.
"While automatic enrollment is proving to be an effective tool for getting employees into the 401(k) plan, it isn't a cure-all for helping people meet their retirement needs," said Pamela Hess, director of retirement research at Hewitt Associates. "Most employees are defaulted at a low rate and into a conservative fund, and they do not take an active role in managing their 401(k) accounts."
Hess observed that recent retirement legislation, such as the Pension Protection Act of 2006 (PPA), includes provisions that encourage employers to add automatic enrollment to their 401(k) plans. However, Hess added, it is also critical that employers "not only focus on getting people into the plan, but also consider the quality of participation." She recommended that companies take time to review appropriate default contribution rates and investment funds; they should also consider coupling automatic enrollment with educational initiatives and other automated tools that force employees to save and invest more wisely.
Confusion and lack of investment knowledge may lead plan participants to remain invested in default funds for long periods of time, and the result can be an extremely conservative investment allocation, Hess added. She noted that, while a large percentage of companies default employees into a stable value or money market account, the PPA and recent Department of Labor guidance encourages companies to use equity-based default options under automatic enrollment.
