Over the past decade, automatic enrollment features have become increasingly common in 401(k) retirement savings plans. If you participate in a 401(k) plan, automatic enrollment can help shoulder some of the load when it comes to making decisions about saving for retirement - but you should not expect it to do the job entirely.
What is automatic enrollment?
One problem with the employee retirement savings system in the U.S. is that it is voluntary. It provides a means of retirement investment and tax incentives for saving, but each individual employee decides whether, how much and in what way to participate. This is unfortunate because employees often are not in a position to understand what they need to do to save for retirement, especially early in their careers.
Automatic enrollment sets a standard retirement deferral level for 401(k) participants, and directs those deferrals into investment options based on each employee's age. Participation is still voluntary because employees have the ability to opt out of these automatic deferrals. However, with automatic enrollment, the default is to do something rather than to do nothing.
Why is automatic enrollment important?
Automatic enrollment is good for retirement savings for several reasons:
- Adds some structure to a defined contribution retirement system. 401(k) plans are known as defined contribution plans because it is the money going into them and not the benefits coming out that are controlled. When participation is left up to individual employees, even the level of contributions going into these plans is not very well defined. By setting up a default level of deferrals, automatic enrollment brings some much-needed structure to this system.
- Helps overcome inertia. It's all too easy to put off starting to save for retirement. Automatic enrollment overcomes inertia by jump-starting the process.
- Saves employees from losing valuable time. Retirement saving takes a consistent effort over a long period of time, and automatic enrollment helps make sure employees don't lose any time in getting started.
- Makes investing less intimidating. Besides prompting employees to put some money aside for retirement, automatic enrollment can direct employees toward the kind of active investments that are appropriate for long-term retirement funding. As a result, employees who do not feel ready to make investment decisions for themselves are not left in low-yielding conservative investments.
- Increases retirement savings accumulation. The Employee Benefit Research Institute (EBRI) did a projection of savings accumulations based on average deferral levels before automatic enrollment was initiated, and then based on deferrals at automatic enrollment levels. The EBRI found that the automatic enrollment model significantly increased retirement accumulation.
- Improves retirement savings among younger employees. The EBRI found that the projected increase in retirement savings was especially great among younger employees, who are typically difficult to convince to save for retirement.
- Encourages low-income employees to save for retirement. The EBRI's projections also found that automatic enrollment could have an especially dramatic effect on retirement savings among lower-income employees, another group that has traditionally lagged in retirement savings accumulation.
As beneficial as automatic enrollment is, employees should not get the impression that it will take care of their retirement savings decisions entirely. Automatic enrollment is better than nothing, but it often won't be enough to provide for adequate retirement savings.
Why is automatic enrollment not enough?
Here is why automatic enrollment alone is not enough to ensure that employees will save enough for retirement:
- Retirement accumulation is better, but still not adequate. The EBRI projections found that for the median worker aged 25 - 29, automatic enrollment would increase retirement savings from under two times final salary to just over six times final salary. That's a step in the right direction, but even six times final salary might not be enough to fund 15 or 20 years of retirement.
- Default allocations are not right for everybody. Automatic enrollment directs employees into investments considered generally appropriate for their situations. However, given the number of variables involved, these generalizations might not always be right for every employee.
- Responsibility rests with the employees. One drawback the EBRI found with automatic enrollment is that when it is in place, employees have a tendency to leave their deferrals at the default levels. In other words, employees assume that automatic enrollment will take care of retirement savings for them, when in fact employees have to step up and assume the ultimate responsibility for themselves.
When it comes to retirement savings, think of automatic enrollment as a gentle push in the right direction. It will help you get started, but you still have to make an effort if you plan on getting anywhere.
Tell us: Are you participating in automatic 401(k) enrollment for your retirement savings? Are there other ways you are growing your savings?
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