401k automatic enrollment may lower savings

Automatic enrollment in 401k plans may be reducing savings rates for some participants, according to a recent study for the Wall Street Journal.

It turns out that the majority of plans (two-thirds) set the default contribution rate to just three percent of earnings, which is lower than what many people would save if they were making their decisions. The Employee Benefit Research Institute found in a study based on 20 million 401(k) participants over an 11-year historical period, that 40 % would have selected higher contribution rates if left to decide on their own. Typically, participants select contribution rates in the 5-10% range.

Here’s the background. In the early days of 401k plans, an employee had to “opt in” to the plan. If the employee took no action, then he or she was not enrolled in the plan. Then Congress revised the law to allow companies to have the default choice–what happens when employees make no decision–be enrollment in the plan. Along with enrollment comes some percentage contribution, as well as an investment choice.

Some programs have adapted an auto-escalation feature, usually a 15 increase annually if the participant was enrolled at the automatic default level, with a maximum of around 6%. Even with these features, according to the studies, 54-73% of employees would fall short of amassing enough funds to retire if they began at the default rate and were only auto-escalated.

The total dollar amount being placed in 401(k)’s has increased by 13% from 2006 to an estimated $284.5 billion, but the contribution percent has declined from an average of 7.9% by each participant, to 7.3%, very likely because of the employees that were auto-enrolled at the 3% level and only increased their contributions by the automatic amount.Don’t misunderstand, we like automatic enrollment, because so many people don’t get around to making the important decisions. Automatic enrollment helps the procrastinators. Something, after all, is better than nothing.

Unfortunately, it may hurt those who would make a better decision if they were not automatically enrolled. Don’t put your 401(k) contributions on “cruise control”, discuss these valuable benefits with your financial advisor as part of your overall Financial Plan. Analyze which funds available in your 401(k) plan best align with your goals and other investments. Review the choices annually, as 401(k) plans will change the available choices each year.

If you fail to choose, you may be choosing to fail, automatically.

Adapted from an article by Dr. Bill Conerly, posted July 11, 2011 on abcInvesting.com

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