401(k) auto-enrollment is great, until it's not

A good effort has been made by companies to get more people to invest in 401(k) plans. One feature that works to boost participation is the auto-enrollment feature that accompanies 401(k) plans. But it’s not perfect.

The offering is both a convenient and effective method for accumulating retirement savings, since a percentage of the employee’s pay is automatically deducted pre-taxed, and then placed in a select investment vehicle. Plans offering automatic enrollment have an employee participation rate of 82%, compared to 65% participation in plans where funds are voluntarily applied, according to Vanguard.

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But there are several problems that arise from auto enrollment.

The majority of employees who use it do so at the default rate, which is 3% of their pay, which was set by the Pension Protection Act of 2006. It has been argued however, that 3% is an insufficient amount to provide for a comfortable retirement. There has been a push to increase the default rate to 6%, which would increase the success rate of retirement savings for both low- and high-income workers.

Losing Track
Some employees choose to voluntarily increase their contributions to the more sensible 6% or more, but those who do so are very few. There remains a problem even in this scenario, because when these employees change jobs, they must remember to increase their withdrawn amounts with their new employer. If they fail to do so, their contributions are automatically reset to the default amount of 3%. Such individuals may go quite a while before noticing their deductions have dropped, which can adversely affect their planned retirement figures.

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Automatic deferral rate escalation is another option that is provided to employees with 401(k) plans, which can increase contributions by 1% annually as well as when employees get pay raises. However, only 40% of all auto-enrollment plans offer auto-deferral rate escalation. Although automatic escalation helps to ease the pain of retirement savings by automatically deducting set amounts from employee paychecks, and the trend is growing in popularity, there are still relatively few employees that utilize the feature.

So why aren’t there more promising results coming from such attractive retirement savings incentives? The answer is a lack of proper education.

There is a disconnect between the 401(k) industry and employees which has resulted in low participation rates. This problem stems from a conversation that focuses on retirement preparedness rather than meeting immediate and pressing financial needs. The solution is to change the conversation to one of financial education and wellness that works to solve current personal financial problems, and boost retirement plan participation rates.

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