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The Downside of 401(k) Auto-Enrollment

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Yet another 401(k) plan administrator is hailing the 2006 Pension Protection Act, which sanctioned the use of automatic enrollment in tax-advantaged 401(k) retirement savings plans.

“The PPA is proving to be one of the most significant legislative initiatives helping American workers save for retirement,” says James M. MacDonald, president of Workplace Investing at Fidelity Investments.

On Nov. 30, Fidelity released a report that shows that 51% of the 11.7 million accounts it administers are covered by plans that feature auto-enrollment, up from 16% in 2006. As a result, Fidelity says, participation rates are rising—to 82% in plans with auto-enrolment, versus 55% for plans without the feature.

The impact on younger workers, Fidelity notes, has been especially dramatic, with 76% of eligible employees ages 20 to 24 participating in plans with auto-enrollment, versus just 20% of those who must enroll voluntarily.

“Auto-enrollment is having a powerful effect on younger” workers, Fidelity notes.

Still, Fidelity doesn’t address the sometimes negative effect auto-enrollment has on the savings rates of participants.

The problem: More than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise. That’s far below the 5% to 10% rates participants typically elect when left to their own devices.

Because simple inertia takes over for many workers, “automatic enrollment is a double-edged sword,” said Brigitte Madrian, a professor at Harvard University who is an expert on 401(k)s. “On the one hand, there’s more participation. On the other hand, lots of employees are stuck at whatever default the employer selects.”

Indeed, 401(k) participants’ average savings rates have fallen in recent years. Among plans Aon Hewitt administers, the average contribution rate declined to 7.3% in 2010, from 7.9% in 2006. The Vanguard Group Inc. says average contribution rates at its plans fell to 6.8% in 2010, from 7.3% in 2006. Over the same period, the average for Fidelity Investments’ defined contribution plans decreased to 8.2%, from 8.9%.

About half the decline “was attributable to increased adoption of auto-enrollment,” according to Vanguard.

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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.