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).”