Automatic enrollment in 401(k) has striking effect

Personal Finance

October 08, 2006|By Eileen Ambrose | Eileen Ambrose,Sun Columnist

The decision of whether to join a 401(k) plan may no longer be up to just you.

More companies are expected to start enrolling workers automatically in their plans in the next year or so. They'll choose how much workers contribute and where to invest their money. And Uncle Sam believes this is for your own good.

Usually, 30 percent to 40 percent of new hires join their employer's 401(k), said Stephen Utkus, a principal with Vanguard Center for Retirement Research. But companies with automatic enrollment see new-employee participation rates jump to 80 percent or higher because few workers bother to opt out.

"It's dramatic," Utkus said.

And he expects dramatic results as more companies adopt auto enrollment. "In a decade, at least half of American participants will be there because it was automatically done for them," Utkus predicted.

Auto enrollment has been around for about a decade.

Even so, only about 15 percent of 401(k) plans use it, and most of those tend to be large company plans, said Michael Weddell, retirement consultant with Watson Wyatt Worldwide.

Employers haven't embraced it partly for fear that auto enrollment might violate state laws on wage garnishment, Weddell said. Others worry about where to invest workers' contributions, and whether the company would be liable if employees lost money.

Some uneasiness

And some companies feel uneasy assuming such a big role in workers' personal savings, preferring employees handle this themselves, Weddell said.

But auto enrollment is effective because it uses workers' inertia to help them save. And with the employer doing much of the work, auto enrollment brings some of the paternalistic features of a traditional pension to the 401(k).

As pensions disappear and so many workers fall behind in saving for retirement, the federal government is trying to remove any roadblocks that may prevent companies from using auto enrollment.

Thanks to the new pension law, for instance, companies no longer need to worry if auto enrollment violates state wage laws.

And Congress added another carrot. Beginning in 2008, companies can avoid certain 401(k) compliance testing if they set up an auto enrollment that meets several conditions.

Among them, workers' initial contribution level must be 3 percent of pay, escalating one percentage point a year until reaching 6 percent. It can stay there, or employers can continue to ratchet up worker contributions to 10 percent of pay.

And employers must provide a match. That can total 3.5 percent of pay for workers contributing to the plan, or 3 percent for all workers whether they contribute or not.

Last month, the Department of Labor proposed regulations to address concerns about where to invest workers' contributions.

Companies typically have played it very safe, choosing conservative investments such as money market funds or stable value funds. The chance of losses is small, but so are the returns.

The Labor Department proposes that workers' money be put into diversified investments that are not too aggressive, but not too stodgy, either, Weddell said.

The department gives the thumbs up to balanced funds, made up of stocks, bonds and cash; a managed account where a professional chooses investments for the worker; and life-cycle funds, where the investment mix gradually grows more conservative as workers approach retirement. Companies, though, would be prohibited from steering workers' contributions into employer stock.

More companies are expected to begin rolling out auto enrollment next year, with the pace picking up in 2008, benefits experts said.

What can you expect if your employer is one of them?

Usually, auto enrollment is reserved for new hires, but more employers will be enrolling current workers who have neglected to join the 401(k), Weddell said.

You will get advance notice and a chance to opt out. Even when money starts coming out of your paycheck, you will have 90 days to back out and get your money back without penalty beginning next year, said Karen Sanchez, a partner with Sikich LLP, an Illinois accounting firm.

The amount of money taken out of workers' paychecks and the employer match could vary widely, experts said.

Usually, workers' contributions start at 3 percent of pay, Sanchez said. And increasingly, employers are raising workers' contributions by one to two percentage points a year, she said. Some plans won't stop until workers are kicking in the maximum dollar amount in the plan, which is $15,000 this year.

The maximum employer match is often 2 percent to 3 percent of workers' pay, she said.

Where will it go?

Where will the money go?

Most employers will likely park workers' contributions in a life-cycle fund based on the worker's age or retirement date, benefits experts said. The fund invests in other stock and bond mutual funds. Younger workers will have a more aggressive portfolio than older workers. And, the portfolio automatically adjusts to be more conservative as workers age.

Employees usually like auto enrollment, said Sanchez, whose firm sets up retirement plans for small and medium-size companies. Often workers are relieved, saying, " `I don't have to do anything, right? You are going to take care of me?'" she said.

Vanguard's Utkus said employees automatically enrolled in a 401(k) can relax if their money goes into, say, a life-cycle or balanced fund and their contributions are increased each year.

"Don't worry about your 401(k)," he said. "Get on with life."

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com. Podcasts featuring Ambrose can be found at baltimoresun.com/ambrose.

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