When Automatic 401(k) Enrollment Is Bad
One of the best 401(k) developments in recent years is the rule allowing companies to automatically enroll new employees in a 401(k). Unless the employee takes positive action and opts out, they’re automatically saving for retirement. But there’s a down side to automatic enrollment. Low contributions, no increases in contributions, and poor automatic investment choices all work to diminish the positive effect of this program. Make sure if you’re enrolled in your 401(k), you know what that means.
- Low contributions
Typically, when a company institutes an automatic enrollment policy, it makes the 401(k) contribution level something anemic like 1% or 2%. Often, it’s not even high enough to get the full company match. Ugh. Sometimes you can’t save people from themselves. Always, always, always contribute in your 401(k) at least enough to get the employer match.
- No increases in contributions
Automatic enrollment plans only enroll people; they don’t periodically increase contribution levels. There is a change to that in 2008 that allows companies to annually increase contributions unless employees opt out. However, I don’t see this being widely implemented. Increase your contribution by 1% per year and I guarantee you won’t even notice. That is, until you look at your 401(k) statement.
- Poor investment choices
Even if companies overcome the barrier to enrollment, they face the sensitive subject of where to put those contributions. A company can’t foresee each employee’s individual financial situation, and what’s appropriate for one person isn’t for another. As a result, often the default investment in automatic enrollment plans is something stupid like a money market fund. Worse yet is company stock as the default investment. You should always check your investment choices to make sure they make sense for you and your situation.
What all this boils down to is that automatic enrollment in 401(k)s is a good idea, it just doesn’t go far enough. So if your company offers it, do yourself a favor and actively look into the program. Don’t just assume you’re all set because you’re “enrolled in your 401(k).”
401k
October 19th, 2007 at 11:11 am
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October 19th, 2007 at 3:39 pm
Actually, the PPA specifically addresses many of the downsides to automatic enrollment that you mentioned. In order for a plan to pass nondiscrimination testing the automatic enrollment has to:
- Start off with a minimum of 3% contribution, and then increase by 1% automatically, without going higher than 10%
- The law now encourages the default investment option to be a balanced, or lifecycle type fund. This can preempt state laws and protect providers from lawsuits, which is the primary reason old automatic enrollment plans used a fixed fund as a default.
So, thanks to the PPA, in coming years new employees who are automatically enrolled will in most cases be starting at a 3% or higher contribution, automatically increase contributions by 1% each year, and be defaulted into an appropriate investment mix.
This doesn’t apply to non-ERISA plans, but for the majority of people with auto enrollment, this will be a big help. Of course, it always pays to be involved with your plan, and save more and invest wisely.