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Understanding 401(k) Plan Automatic Enrollment

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measuring_401kSaving for retirement is a big job. The auto-enrollment features of 401(k) plans can give you a boost to help you get started; but if you rely on them completely, you may find your retirement savings fall short of your needs.

If your 401(k) plan has automatic-enrollment features, you should understand what those features can do for you and what you may need to do for yourself.

What is automatic enrollment?

The past 40 years or so have seen the corporate-retirement-plan system largely shift from defined-benefit pensions provided by employers to defined-contribution plans that rely on voluntary contributions from employees. The problem is it often takes employees a while to realize the importance of saving for retirement and how they should go about it. As a result, many people get behind in their retirement saving because they start late and, once they do start, they often begin too slowly and have trouble figuring out how to invest.

Automatic enrollment can jump-start a person's retirement savings. It sets a standard contribution deferral level for 401(k) participants and directs those deferrals into investment options based on each employee's age. Participation is ultimately still voluntary because employees have the ability to opt out of these automatic deferrals; but with automatic enrollment, the default is to do something rather than to do nothing.

>> Need more information? Read 401(k) Retirement Savings Plan Basics

How is automatic enrollment helpful?

Automatic enrollment helps people save for retirement in several ways:

  1. Adding structure to 401(k) retirement programs

    401(k) plans rely heavily on decisions made by plan participants, including how much to save and how to invest it. Most employees are not well prepared to make these decisions, so automatic enrollment guides them in the right direction with default options for participant deferral rates and investment choices for employees who don't want to make those decisions themselves.

  2. Overcoming inertia

    It's all too easy to put off saving for retirement. Automatic enrollment gets employees started unless they actively choose to opt out. This has helped get more people into the saving habit.

    According to a study by Vanguard, a major provider of retirement plan services, 92 percent of eligible employees participate in their 401(k) plan when it has automatic-enrollment features, compared to just 57 percent of eligible employees who participate when their plans rely solely on voluntary participation.

  3. Saving valuable employee time

    Retirement saving takes consistent effort over a long time, and automatic enrollment helps make sure employees don't lose any time getting started. Vanguard found that roughly four out of ten 401(k) plan participants today got their retirement savings started through automatic enrollment.

  4. Making the investing process less intimidating

    Besides prompting employees to put some money aside for retirement, automatic enrollment can direct employees toward the kind of growth 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.

  5. Encouraging people to ramp up savings over time

    Because wages are relatively low for most people early in their careers, it is necessary not just to start retirement saving early but also to ramp up savings over time in both dollar amount and as a percentage of salary deferred into retirement savings.

    Vanguard found that most 401(k) plans with automatic enrollment also have automatic deferral-increase features, which gradually increase the percentage of an employee's pay going into the plan unless the employee chooses a different deferral rate.

It seems clear that, without automatic enrollment, fewer employees would be participating in 401(k) plans; and of those that do, many would be making less appropriate investment choices. Automatic enrollment helps get people started in the right direction, but it is not likely to do the entire job of retirement saving for you.

>> Calculate your retirement savings needs: Use our retirement savings calculator

Why isn't automatic enrollment enough?

Automatic enrollment takes some key decisions out of employees hands if they choose not to make them - when to start investing money in the 401(k) plan, how much to defer into the plan and how to invest it. So why isn't it enough to rely on automatic enrollment to make these decisions for you?

It might help to think of automatic enrollment as a way to prime the pump of retirement saving - it can yet you started; but on its own, it is not likely to produce enough for a fully funded retirement. Here are some reasons why:

1. Default-deferral rates are fairly low

Vanguard found that the most common default-deferral rate used by 401(k) automatic enrollment programs is 3 percent. That's a start, but is probably not sufficient to allow you to accumulate enough money for retirement. It's also not enough to fully take advantage of most employer-matching-contribution programs. Automatic enrollment deferrals should be thought of as an entry level that you should strive to move well beyond.

2. Default allocations are not right for everybody

According to Vanguard, almost all (97 percent) of automatic-enrollment programs direct employee contributions into a target date fund based on the employee's age. This is a reasonable move in most cases, but not everybody of the same age has the same investment needs. Your lifestyle, current amount of retirement funding, debt outstanding and plans to retire early are all factors other than age that can affect your investment choices.

>> Insider Tip: Think of the plan's default investment allocation as an approximation of your retirement needs which you should then tailor to your particular circumstances.

3. Long-time employees may be left behind

Use of automatic enrollment by 401(k) plans soared from just 1 percent of plans in 2003 to 46 percent in 2017. However, Vanguard's survey also found that roughly half of those plans using automatic enrollment implement it only for new hires. Employees in such plans who were on board before automatic enrollment was adopted would be left out of it - though such long-time employees may be most in need of boosting their retirement savings if they've been slow to get started.

4. Automatic enrollment may encourage employees to take their hands off the wheel

Letting an automatic enrollment program make certain decisions for you might imply that you have no responsibility for those decisions for yourself. Tellingly, Vanguard found that, among plans with strictly voluntary participation, the average participant-deferral rate of 7 percent was slightly higher than the 6.7 percent average-deferral rate of automatic-enrollment plans.

These aren't exactly apples-to-apples comparisons. Remember, automatic-enrollment plans have much higher rates of employee participation - but they do imply that people who actively opt in to a plan are likely to make a larger commitment to retirement savings than those who are enrolled automatically.

The nature of defined-contribution plans like 401(k)s is that responsibility for retirement savings lies primarily with the employee. Automatic enrollment is a gentle push in the right direction, but you must add your own efforts to make sure you save enough and are invested appropriately to meet your retirement needs.


More resources on saving for retirement:

Starting your career? How to start a retirement fund in your 20s

Health or wealth: juggling HSA and 401(k) contributions

How to use a health savings account to build retirement wealth

Financial checklist: How to invest in your 20s


More resources on asset allocation

Portfolio rebalancing: Rebalancing an investment portfolio

How do I invest my 401(k) two years from retirement?

Impact investing: Is it right for your portfolio?

Commercial paper for individual investors

How investors can identify stock market cycles

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