One of the most significant trends taking place in workplace retirement plans is the adoption of automation, and according to a recent report from T. Rowe Price, that trend is continuing. According to analysis of the more than 650 plans covering more than two million participants that the company manages, some 85% of plans now use auto-enrollment, whereby new employees are automatically enrolled in their employer’s 401(k) or similar plan.
The employees have to choose to opt out, if they so wish, rather than having to opt in, and that has had a big impact on participation rates. In 2022, 86% of employees working for companies with auto-enrollment participated in their employer’s workplace retirement plans, whereas just 37% chose to do so at companies that did not use auto-enrollment.
Some cautions
One of the early knocks against automated workplace retirement plans was that the automated contribution rate was too low. In 2017, the default rate moved up from just 3% to 6% of salary. Even though employees can chose to contribute more, contribution rates continue to hover at levels that are likely to be too low to generate sufficient retirement savings. In 2022, the average contribution rate at T. Rowe Price-managed plans was 8.4%, which was down slightly from the year before.
Another limitation of automated workplace retirement plans is that some participants may be too hands-off for their own good, creating many “unintentional thousandaires” — people who seem to wake up one day and realize they have a lot of money in their retirement plan, and they want that money! Despite penalties, taxes, or at very least the opportunity cost of missing out on long-term tax-advantaged growth, many participants cash out their 401(k)s when changing jobs while others sacrifice portfolio growth by borrowing from their nest egg.
A study cited by The Wall Street Journal found that “within eight years of joining a 401(k) plan... automatically enrolled workers withdraw nearly half of the extra they manage to save, compared with workers left to sign up for the retirement plan on their own.”
According to Harvard economist Brigitte Madrian, “We have figured out how to get money into the retirement savings system [using auto-enrollment]. Now we need to think about how to keep that money in the system.”
Some opportunities
There are several steps workplace retirement plan participants can take to improve their retirement readiness.
First, know how much you should contribute. Even running a fairly simple analysis with a free online tool such as Fidelity’s Retirement Score calculator can give you a feel for how much you should be saving each month for retirement. More sophisticated free tools are available as well. And SMI Premium members are encouraged to take advantage of the opportunity to use Envestnet MoneyGuide.
Another important decision regarding retirement saving is determining how much to contribute to which type of account. SMI has a free decision tree that offers guidance for using a workplace plan in conjunction with an IRA and a health savings account.
Second, know which investments to choose. Target-date funds have become the default investment in the vast majority of automated workplace retirement plans. They are not necessarily a bad choice, but their limitations need to be understood. For starters, if you plan to retire in 20 years, for example, a fund with a target retirement date about 20 years down the road may or may not use an asset allocation that’s appropriate for you. Run your own optimal asset allocation analysis and choose a fund with that allocation.
Also, know that a target-date fund’s only mechanism for dealing with market downturns is its bond allocation, and as we saw in 2022, bonds fell right alongside of stocks. Consider using SMI’s Personal Portfolio Tracker to manage your workplace plan investment decisions. And even if you decide to use a target-date fund, you could use Upgrading’s objective moves to cash to decide how much of your portfolio to have invested in that fund.
If you participate in an automated workplace retirement plan, how have you struck a good balance of taking advantage of its benefits while working around its limitations?
