Thursday, July 7, 2011

WSJ: 2006 401K Law Supresses Saving for Retirement

Hmmm, some interesting unintended consequences of a law passed in 2006 which one would think would have increased savings. 

The study shows while more people are participating, those who are automatically enrolled due so at the company set rate, which is below what people who enroll on their own normally do.  Hence inertia is an issue.    I'd also argue one potential issue is the timing of the law - it happened just before the beginning of the Great Recession so far fewer people have jobs (and hence 401ks), and those who do retain employment don't have the house ATM to utilize as their secondary piggy bank - hence have less for retirement savings.  But plain inertia might be the primary cause.

Via WSJ:

  • A 2006 law designed to boost employees' retirement-savings is having the opposite effect for some people.   Under the law, companies are allowed to automatically enroll workers in their 401(k) plans, rather than require employees to sign up on their own. The measure was intended to encourage more people to bulk up their retirement nest eggs—a key goal in a country where millions of people aren't saving enough.
  • But an analysis done for The Wall Street Journal shows about 40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily, the Employee Benefit Research Institute found. The nonprofit performed a complex computer simulation of savings patterns drawing on data from more than 20 million 401(k) participants.
  • The problem: More than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise. That's far below the 5% to 10% rates participants typically elect when left to their own devices, the researchers said.
  • "Automatic enrollment is a double-edged sword," said Brigitte Madrian, a professor at Harvard University who is an expert on 401(k)s. "On the one hand, there's more participation. On the other hand, lots of employees are stuck at whatever default the employer selects." 
  • The total annual amount being put into 401(k) plans has increased by 13% since 2006, to an estimated $284.5 billion this year, according to consulting firm Cerulli Associates. That is largely because the rule has successfully prodded millions of people who wouldn't have saved a penny for retirement to start saving something. 
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  • EBRI evaluated the contribution rates of people of similar ages and salary levels eligible for 401(k) plans with automatic enrollment versus those in plans that require workers to join voluntarily, examining data stretching back 11 years. To project future savings patterns among auto-enrolled participants, EBRI ran a computer simulation based on a variety of scenarios concerning wage growth and the adoption of higher contribution rates over time.
  • Simple inertia takes over for many workers, said Kristi Mitchem, head of the global defined-contribution business at State Street Global Advisors, which manages more than $297 billion in 401(k) plans.
  • The Pension Protection Act of 2006, which was designed to shore up the pension system, also encouraged wider adoption of auto-enrollment in 401(k) plans. It removed obstacles such as state laws that restricted the practice and shielded employers who use certain types of investments from liability for losses suffered by participants who are auto-enrolled.
  • The law has boosted auto-enrollment and participation rates dramatically. About 57% of large companies now automatically enroll new employees in 401(k) plans, up from 24% in 2006, according to Aon Hewitt. While employees are free to opt out, companies report average participation rates above 85%, compared with 67% for those without auto-enrollment, Aon Hewitt says.
  • Yet 401(k) participants' average savings rates have fallen in recent years. Among plans Aon Hewitt administers, the average contribution rate declined to 7.3% in 2010, from 7.9% in 2006. The Vanguard Group Inc. says average contribution rates at its plans fell to 6.8% in 2010, from 7.3% in 2006. Over the same period, the average for Fidelity Investments' defined contribution plans decreased to 8.2%, from 8.9%.  Vanguard estimates about half the decline "was attributable to increased adoption of auto-enrollment."
  • Many companies said they selected a 3% default contribution rate in part out of concern that a higher rate could prompt employees to drop out of these plans.  
  • Another factor may be pushing down default rates: Some companies that match some employee contributions can save money with a lower default rate. According to a 2011 Aon Hewitt survey, 73% of employers without auto-enrollment cite "the increased cost of the employer match as a primary barrier" to adopting it this year.

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