Why automatic 401(k) enrollments fall short
October 18, 2011
A recent study by Vanguard touted the benefits of companies auto-enrolling their employees in 401(k) retirement savings accounts, noting that automatic enrollments have made retirement savings more uniform among employees at those companies.
The advantage with auto-enrollment is that it forces employees to deliberately opt out. Since the default deduction from their paycheck is relatively small--most companies set the contribution rate at 3 percent--the employees aren't as likely to see the diversion as a major hit on their take-home pay. Savings rates like that seem doable.
So they let it go.
The problem with this picture is that 3 percent is a long way from the level most of these workers should be putting money into retirement savings accounts. Unless the employee researches the matter and establishes a written retirement plan--and most people don't--he or she may be operating under the assumption that 3 percent is sufficient for a happy retirement. It's better than the best CD rates, isn't it?
But consider these figures from a recent Ariel/Hewitt study: Among workers earning between $30,000 and $59,000 a year, blacks have average 401(k) savings accounts of $21,224 and Hispanics have $22,077. The average balance of retirement savings accounts for whites in this salary level is $35,000, and even that is a long way from the $300,000 to $500,000 that financial planners recommend people at this salary level have by retirement.
Not surprisingly, a recent study by Allianz Life Insurance found that more than half of American workers wonder if their 401(k)s are enough for a secure retirement. More than 25 percent of American workers say the best place to save for retirement is not a money market account or online savings account, but a mattress. That's not a euphemism for anything--these people are saying that stuffing bills under their bed is just as good to them as putting it in an account.
If the country is going to forgo pensions and forsake Social Security, as many consumers worry, employers are going to have to embrace automatic escalation, or the process of automatically increasing the savings rates for their employees. Some state retirement plans already do this.
Another good step would be to auto-enroll employees into target date funds. Some companies already do this. Target date funds are highly diversified, and the risk level is determined by the "target date," which is often the year the employee would normally expect to retire. This reduces the possibility that employees will invest too much money in "growth" or "aggressive growth" funds, which have great returns when the stock market is climbing, but can inflict heavy and inappropriate damage when stocks plummet--a particularly bad thing when the investor is close to retirement.