Automation now rules workplace retirement plans, such as 401(k) and 403(b) plans. Employers commonly enroll a new hire in the company plan automatically, while also automatically setting an employee’s contribution rate and selecting their investments.
On the positive side, the adoption of automatic enrollment, sparked by the 2006 Pension Protection Act, has boosted retirement-plan participation rates dramatically. “Among new hires, participation rates more than tripled to 91% under automatic enrollment, compared with 28% under voluntary enrollment,” according to a 2020 Vanguard study.
However, are the decisions being made on behalf of employees the right decisions? If you participate in a highly automated workplace retirement plan, here are points to consider.
Is it enough?
A decade ago, nearly half of automatic-enrollment plans set an employee’s initial contribution level at only 3% of salary, far below the amount most people would need to contribute to be well-prepared for retirement. Fortunately, average default deferrals have risen since then. Today, more than half of employers with auto-enrollment policies set the default contribution at 5% or 6% (or more), according to a survey of plans administered by T. Rowe Price.
And, to get employees moving beyond the initial deferral rate, some employers have implemented “auto-escalation” protocols that increase an employee’s contribution each year—typically by 1%—up to a predetermined ceiling, often 10%.
Auto-escalation is relatively new, and early research suggests mixed results. A Vanguard study of employees hired in 2017 found that after three years, “about half of participants remain[ed] in the original automatic plan design, including the automatic increase feature.” Interestingly, among those employees who asked for a change in the default deferral, most boosted contributions more than the auto-escalation target.
Still, the Vanguard study found that participant contribution rates after three years on the job averaged slightly less than 8% of salary, although matching contributions from employers boost many employees to the equivalent of 10% of their salary or more.
Of course, optimal contribution rates will vary from person to person, depending on one’s age, existing savings, future lifestyle, and several other factors. To discover what your optimal rate should be, we suggest using an online retirement planning calculator. (Fidelity’s Retirement Score calculator is a good place to start. Or consider using the MoneyGuide software, available to SMI Premium-level members.)
Are your investments on-target?
In most cases, employees “nudged” into a company retirement plan (via auto-enrollment) have an investment option selected on their behalf as well: a target-date fund. Such funds provide a built-in asset allocation plan that the fund company deems appropriate based on a participant’s age. As an investor nears retirement age, that stock/bond mix automatically becomes more conservative.
The appeal of target-date funds (TDFs) is understandable, but the details matter. Asset-allocation models can vary from fund company to fund company for TDFs that target the same retirement year. (All target-date funds include a year in the fund name, such as “2045.” The idea is to invest in a fund that uses a year close to your intended retirement date.) So it’s wise to learn about your default fund’s asset allocation and the specific “glide path” — the shift from stocks toward fixed-income investments — that it will follow as the target date nears.
Here again, you would be wise to use an online calculator to determine your optimal asset allocation and be sure the fund you’re using reflects that allocation.
Are you willing to wait?
There’s no doubt that automated retirement plans have helped expand employee participation, but they have also created 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.”
So, despite how easy it is to access money early — and how tempting — keep in mind that the purpose of a 401(k) plan is to help you save for retirement!
If you participate in a company retirement plan in which your employer makes decisions on your behalf, the start of a new year is an excellent time to review your options. Use freely available online calculators to figure out how much you should be contributing. Also determine your optimal asset allocation and decide if a target-date fund is right for you (and if so, which one).
Automation can be a great help in starting to save for retirement. Ultimately, though, meeting your goals may require making different decisions than the ones that have been made for you.