401(k) Auto-Enrollment Is No Cure-All for Our Retirement Woes

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By Eleanor Laise

If your 401(k) is on autopilot, it may be time to grab the wheel.

A growing number of employers are adding automatic features to these workplace retirement-savings vehicles, typically sweeping new hires into the plans and setting workers' contributions at 3 percent of pay.

Workers can always opt out of the 401(k) auto-enrollment features, but they usually don't-and their willingness to put savings on autopilot is both good and bad news. On the plus side, automation leads many who would otherwise save nothing to steadily sock away a slice of their paycheck. But the 3 percent default contribution rate favored by employers doesn't come close to the savings rate needed for a secure retirement: roughly 12 percent to 15 percent, experts say, including both worker and employer contributions. A 3 percent contribution isn't even enough to get the typical employer's full 401(k) matching contribution, meaning many workers are skipping the only free money they'll ever see.

Employers' embrace of the 3 percent default gets more troubling when you quantify the benefits that could come with smarter automatic features. The Employee Benefit Research Institute recently looked at the potential impact on workers' retirement success rates if plans that automatically enroll workers and increase participant contributions annually were to boost their initial default contribution rate to 6 percent. (EBRI defined retirement "success" as a 401(k) balance that, when combined with Social Security benefits, replaces 80 percent of pre-retirement income after adjusting for inflation. The study focused on younger workers with at least 30 years of 401(k) eligibility. EBRI assumed that workers' opt-out rates would remain stable and that workers would start over at the default contribution rate when changing jobs.)

The results: The simple jump to a 6 percent default contribution produced striking improvements in retirement success rates for workers across the income spectrum. With the higher default contribution, nearly three out of four workers in the lowest income quartile would be on the path to a secure retirement, EBRI projects, compared with just 62 percent under current default contribution rates. That means that more than a fourth of the workers previously on a collision course with retirement mayhem would have a brighter future.

Even the highest-income workers would see a substantial benefit. Nearly 20 percent of those currently not saving enough would see retirement success with a 6 percent initial default contribution, EBRI projects.

While some employers have adopted the 6 percent solution, they're exceedingly rare. About 46 percent of plans automatically enroll workers, according to the Plan Sponsor Council of America, a group for employers offering retirement plans. Just 11 percent of those auto-enrollment plans set the default contribution at 6 percent or higher. Nearly seven out of 10 set the default at 3 percent or less. And though most auto-enrollment plans also offer to automatically increase workers' contributions annually, nearly 80 percent of these plans cap the auto-increases at 6 percent of pay or less, according to PSCA.

Budging From the 3 percent Default Rate

Given what's at stake, it's tough to find a satisfactory explanation for the 3 percent default's popularity. The most commonly cited employer objections to boosting default contribution rates hardly seem insurmountable-and some seem disconnected from reality. Some retirement experts point to an old IRS ruling that used a 3 percent default in an example of an auto-enrollment plan that would pass regulatory muster. But there's really no legal barrier for employers to choose higher default rates, experts say. "It's not that the IRS ever said, 'if you go above 3 percent, you're in trouble,' " says Jack VanDerhei, research director at EBRI.

Another employer objection: "Some plan sponsors believe their employees can't afford higher savings rates," says Jean Young, senior research analyst at Vanguard Center for Retirement Research. "We can show them that's actually not the case." Vanguard's research suggests that workers' 401(k) opt-out rates don't change with the level of the default contribution rate. In fact, it has found that workers earning less than $30,000 contribute 50 percent more, on average, when left to their own devices in totally voluntary 401(k) plans than in automatic-enrollment plans where employers set the default contribution.

A third employer objection: "Cost is always an issue," says Bob Benish, PSCA's executive director. The most common employer matching contribution is 50 cents on the dollar up to the first 6 percent of pay, Benish says. If plans boost the default contribution to 6 percent, far more employees would collect the full employer match-taking more money out of the company's pocket. But employers could restructure the match so that the higher default rate would cost them little or nothing-and simultaneously give workers a great incentive to save more. An employer that previously matched worker contributions dollar for dollar up to 4 percent of pay, for example, could instead match 50 cents on the dollar up to 8 percent of pay.

Asking participants to double their savings rate to get the same employer matching contribution may not draw cheers from many workers-but ultimately, neither will 401(k) plan designs that leave retirees struggling to make ends meet.

While research piles up in support of higher default contribution rates, workers shouldn't wait around for employers to rethink their 401(k) plans. Seize control: Contribute at least enough to get the full employer matching contribution, and work toward the 12 percent to 15 percent total savings rate that retirement experts recommend. You may not get there overnight-but you won't be asleep at the wheel while your savings putter along in the slow lane.

Best States for Retirement Aren't the Ones You Might Think
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401(k) Auto-Enrollment Is No Cure-All for Our Retirement Woes
Not only does it have a Florida-like climate, but Tennessee also boasts the second lowest cost of living in the country. Combined with a low tax burden and great access to medical care, Tennessee is ideal for retirees living on fixed incomes, Kahn said. The only downside: the state has one of the country's highest crime rates.

One of the state's oldest towns, Sevierville, Tenn. (pictured above), provides close access to a national park where retirees can picnic, hike and fish, and it's an easy drive to Knoxville.
Another balmy locale, the state has an average temperature of 66.7 degrees -- behind only Hawaii and Florida for warmest average climate. Louisiana residents also enjoy low taxes, above-average access to medical care and a relatively cheap cost of living. Like Tennessee, though, it suffers from a crime rate that is among the nation's highest.

It may not be a retirement hot spot, but Bankrate says it should be. The state has the country's lowest crime rate, and an estimated state and local tax burden of just 7.6% -- lower than every state but Alaska. The downside: with an average temperature of 46 degrees over the past 30 years, it's pretty darn cold there.

For small town lovers, Aberdeen, S.D., holds a renowned film festival and has a historic downtown that plays host to farmers markets, haunted walking tours and holiday parades.

Photo: Conspiracy of Happiness, Flickr.com

The Bluegrass State is one of many Appalachian states to dominate Bankrate's top 10. While it may not have Florida's sunny beaches, it does boast an extremely low cost of living, warmer-than-average temperatures and a below-average crime rate.

In Louisville, retirees can stay active by walking or biking on the Louisville Loop, a pedestrian path set to eventually cover more than 100 miles. The smaller town of Danville, Ky., meanwhile, is ideal for horse lovers.

Beyond its warm weather, Mississippi also provides cheap living costs and a lower tax burden. But retirees may want to choose where they live carefully: the state has a high crime rate and subpar access to medical care. It has only 178 doctors per every 100,000 residents -- almost 100 less than the national average.

Photo: Natalie Maynor, Flickr.com

This coastal state came in above average for most factors that Bankrate analyzed, including climate, access to healthcare and cost of living. Its crime rate is one of the lowest in the country, with only 2,446 property and violent crimes per 100,000 people.

An affordable college town, Lynchburg, Va. offers the beauty of the foothills of the Blue Ridge Mountains, as well as historic Civil War sites.

Another Appalachian state, West Virginia is boosted onto the list by low crime, a cheaper cost of living and above-average access to medical care. Still, it has a colder climate than some of the other states.
Warm temperatures, low state and local taxes and a relatively low cost of living all pushed Alabama into the top 10. Yet it suffers from below-average access to medical care and a relatively high crime rate, with 4,026 crimes per 100,000 people -- almost double that of Virginia.

Home to a campus of the University of Alabama, Huntsville, Ala. offers botanical gardens and nature preserves and 19th century architecture. Near the Georgia border, Fort Payne, Ala. is a quintessential small town with activities that include an annual fiddling convention and a stop at the "world's largest yard sale."

Beyond its cornfields, Nebraska offers excellent access to hospital care, a below-average crime rate and living costs among the country's cheapest. But with a lower than average temperature, it's another state for retirees who don't mind the cold.
Like neighboring South Dakota, this state is not for retirees looking for warm weather. But it does have the second lowest crime rate in the nation, a mild estimated tax burden of 8.9% and 5 hospital beds available for every 1,000 residents.

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