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Automatic 401(k) Enrollment Can Be a Costly Benefit

Study: Many workers fail to upgrade from low-contribution, low-risk default options, to portfolios' detriment.


Automatic enrollment in 401(k)s, an increasingly popular strategy used by companies to raise workers' participation rates in the savings plans, may hurt employees rather than help in the long run, according to a study released Tuesday.

Hewitt Associates, a benefits consulting firm, found that workers who are automatically signed up for 401(k) plans tend to stick with the default savings rate, which is usually only 2% to 3% of their pay, and the default investment option, typically a money market mutual fund or similar conservative vehicle.

That combination ultimately can be harmful to workers' retirement security, the firm said.

"Automatic enrollment really is a trade-off," said Lori Lucas, a defined-contribution consultant at Lincolnshire, Ill.-based Hewitt. "It's helping those most at risk, the lower-wage and younger employees" by getting them started saving and enjoying the benefit of any company savings subsidies.

"But for those average participants who might have joined the plan anyway after a couple months or a year, they may be saving less aggressively than they would have if they joined on their own--and less aggressively than they should be," she said.

The study, which looked at 401(k) savings by 100,000 workers at three large U.S. companies over a two-to-three-year period, found that automatic enrollment brought plan participation rates up to an average of about 80% at the firms from about 60% before they established the system.

A 401(k) lets workers save for retirement tax-deferred, often with matching employer contributions.

Hewitt found that although automatically enrolled employees tend to move away from the default investment choices over time, they stick with them more often than employees who sign up voluntarily.

After five months on the job, 76% of automatically enrolled employees still contributed at the default rate and to the default investment. After 26 months, that dropped to 39%.

Yet just 2% of employees hired before the implementation of automatic enrollment were in default mode, Hewitt said.

Not only should employers stress the need for workers to take prudent risks by investing in stocks when appropriate, Lucas said, but default savings rates and fund choices also should be rethought.

Rather than a money fund or cash-like stable value fund, firms might consider a balanced fund, which combines stocks, bonds and cash, as the default choice, she suggested. Also, default savings rates could be raised, she said.

Though it would seem that the minimum savings rate is better than nothing for workers who would never have signed up for 401(k) plans without a push, that may not be true if the issue is building a retirement nest egg, Lucas said.

"With a lower quality of participation, there's not a lot of opportunity for their portfolio to grow," she said of workers saving in default mode. "That makes it much more likely they will cash out when they leave the job, rather than rolling [the savings] into a new plan" and leaving it for retirement.


Passive Participation

Workers automatically enrolled in 401(k) plans often stay at the default contribution rate, typically only 2% to 3% of pay, and stay with the default investment, generally a money market fund or similar conservative option, a study shows.

Percentage of employees contributing at 401(k) default savings rate and to default fund choice:


Automatically enrolled employees after five months' tenure: 76%

Automatically enrolled employees after 26 months' tenure: 39%

Employees hired before automatic enrollment: 2%

Source: Hewitt Associates

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