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The Downside of 401(k) Auto-Enrollment


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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    • Remarkable question

    • The analysis in this article is sloppy and misses the mark. We expect better from the WSJ.

      The “downside” note in the article is that the contribution set for for automatic enrollment is 3%. But this is an improvement for those “lazy savers” that would not have otherwise saved anything to a 401k (and would have missed out on matching contributions, if their employer offers them).

      As for the “motivated savers” — these are individuals who are would have participated in 401ks without automatic enrollment and according to the author, would set a higher contribution rate if left to their own devices. These are motivated savers–they will take the time to increase their contribution rates upwards from the automatic 3%.

      The implication of the article is that setting automatic contribution rates at 3% will cause “motivated savers” to contribute less. This conclusion is questionable and the article provides no basis to support this.

      Motivated savers are the same people who, by definition, had sufficient motivation to overcome inertia and enroll in 401ks without the need for automatic enrollment. As the author says, left to their own devices these savers would have set contribution rates of 5% to 10%. Where is the evidence that automatic enrollment will stop motivated savers from raising their contribution rates from the automatic rate?

      The only statistic cited is that “average” saving rates are going down. However, this is not surprising. If you take a pool of motivated 401k savers, and add a bunch of lazy savers into the pool (at 3% contribution) the average contribution rate will go down. But that doesn’t mean that the motivated savers in the pool are decreasing their contributions or saving any less than they otherwise would.

      Overall, automatic enrollment sounds like a good thing. The motivated savers keep doing what they are doing (at least most of them). And the lazy savers save more than they otherwise would have.

      So what if the average contribution rate of 401k participants goes down? Remember, the lazy savers were contributing 0% before automatic enrollment. Now they are contributing something and the overall amount that employees are savings has increased.

    • I don’t like the direction of this article. The author complains that the auto-enrollees are saving too small of a percentage of their salary, but seems to be forgetting that they WERE saving, and would likely have continued to save, 0% without the auto enroll. At least this program has them doing something, even if it isn’t enough.
      The fact that they have now started the 401k is still a wonderful thing. If it takes another 5 or 10 years before they get serious and bump up the contributions, at least they have some base to start from. We can’t force every good decision down someone’s throat, but I think starting like this is a great thing.

    • Rising participation rates don’t tell the whole story. What if more employees are participating under automatic enrollment, but they view their 401(k) like a short term savings account and are taking out loans or making “hardship” withdrawals? These studies should also track account balances net of loans.

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  • 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.