Limits of automatic 401(k) plans

With low contribution amounts, retirement savings fall short

Automatic enrollment in 401(k) plans, which is on the rise, appears to significantly boost participation in the plans, but the process may leave some workers with too little in savings when they retire.

Those insights were revealed in a new report from the General Accounting Office.

The way the programs work, workers are automatically enrolled unless they opt out.

The percentage of plans with automatic enrollment policies jumped from about 1 percent in 2004 to more than 16 percent this year, the report revealed. It found that participation rates by workers can reach as high as 95 percent under automatic enrollment.

But due to low initial worker contribution rates in some of the programs, the fact that some lack features to automatically increase savings rates over time and that some invest in less aggressive funds, retirement savings for workers could fall short, the report noted.

"The benefits of automatic enrollment have been we've gotten a lot of people to save that maybe wouldn't have done so without it," said Pam Hess, director of retirement research at Lincolnshire-based Hewitt Associates, a benefits and human resources consulting company.

"But the downsides are clearly that maybe people aren't saving enough."

When workers are automatically enrolled into 401(k) plans their awareness of their savings is a lot lower than active investors, Hess said.

She added most automatic enrollment programs take 3 percent to 4 percent of workers' pay and put it into their retirement accounts, which is lower than what active investors do. And the savings rate is sometimes too low to qualify for an employer contribution match.

The GAO report also said the use of target-date funds as an automatic enrollment vehicle raises questions. Target-date funds allocate investments among various asset classes, like stocks, and shift to lower-risk investments as a "target" retirement date approaches, such as the year 2020, 2025, or 2035. Investors are defaulted into funds based on their present age and a 67-year planned retirement age. But such funds suffered substantial losses in the past year.

"Target-date funds are a great investment especially for younger workers because people are more like the average, they're more like one another," Hess said. "As folks get closer to retirement, it's just so important that they have a plan for themselves because at that point, investors are more unique. Do they have a spouse? Do they have a pension? Where they are at with their retirement savings is going to vary dramatically person to person."

The report is a reminder of how important it is that workers make sure enough money is being contributed to their 401(k) retirement plans to reach their long-term goals, Hess said.

For workers in automatic enrollment plans, she offered this advice:

• Check to see what percent of your salary you're contributing. If you can contribute more, do so.

• If your company matches employees' 401(k) contributions, make sure you're contributing enough to qualify for that match.

• Check to make sure the fund you're enrolled in is the right one for you. Find out how the assets are allocated and if you're comfortable with the risks.

• Take advantage of help that might be available from your employer to put your savings on autopilot and help you save more, such as mechanisms that automatically increase your contributing over time and automatic rebalancing of your account to ensure it stays properly diversified.

• If you leave your employer, don't cash out of the plan. With automatic enrollment, people are less aware that they've been defaulted into a plan and sometimes have small balances when they leave a company, Hess noted.

"But every $1,000 helps," she stressed Hess.

"If you're 25-years-old, and you have $5,000 saved and you think that's not meaningful, it's very meaningful. The power of compounding is just dramatic. Starting early, even with a little bit, adds up so much over time."