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Automatic 401(k) Enrollment Depresses Overall Savings Rate

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In the wake of the Pension Protection Act of 2006, the number of companies that automatically enroll new employees in their 401(k) plans has risen dramatically. About 57% of large companies now do so, up from 24% in 2006, according to Aon Hewitt.

Although employees are free to opt out, few do. As a result, companies that auto-enroll report average participation rates above 85%, compared with 67% for those without auto-enrollment, Aon Hewitt says.

But the trend is actually having a depressing affect on the overall savings rates of 401(k) participants, according to 401(k) plan record-keepers, The Vanguard Group and Aon Hewitt. (Vanguard is quoted to that effect in a recent article in the Wall Street Journal on this topic.)

The reason: More than two-thirds of companies set default contribution rates under auto-enrollment at 3% of salary or less. That’s far below the 5% to 10% rates participants typically elect when left to their own devices. (Employees who are auto-enrolled are free to raise their contribution rates—or drop out of these plans entirely. But many tend to stick at the default contribution rate, either temporarily or permanently.)

It is even farther below the savings rates that Vanguard, for one, estimates are necessary to ensure a secure retirement.

According to page 35 of “How America Saves 2011: A Report on Vanguard 2010 defined contribution plan data,” those with incomes below $50,000 should save 9% of salary or more, a number that includes a company match; those with incomes between $10,000 and $100,000 should save 12% or more; and those with incomes above $100,000 should save 15% or more. The reason for the range: Social Security replaces a greater portion of income for individuals in the lower brackets.

“While automatic enrollment gets more people into the plans, it doesn’t help get them to an adequate level of savings,” says Stephen Utkus, director of the Vanguard Center for Retirement Research.

In response, companies that administer 401(k) plans—including Aon Hewitt, Fidelity Investments, The Principal Financial Group, and Vanguard—say they are pushing employers to raise initial contribution rates under auto-enrollment to 6% or more. Many are also promoting so-called auto-escalation programs. Under these, employers automatically increase participants’ savings rates—typically, by one percentage point per year until deferrals reach a specific threshold that’s generally between 6% and 10% of pay. But while a large fraction of automated 401(k) plans have such programs, most require employees to enlist voluntarily—something few do.

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About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.