Caution: 401(k) Auto Enrollment Could Be Bad for Your Retirement

Last Updated Dec 16, 2009 11:52 AM EST

According to a new research paper released by the Center for Retirement Research at Boston College firms that adopt an auto enrollment feature for their 401(k) end up making lower company matches than firms that haven't switched to auto enrollment. Mauricio Soto and Barbara A. Butrica of the Urban Institute found that plans with auto enrollment dole out a matching contribution that is 7 percentage points lower than firms that don't.

It's easy to see why. When a firm enrolls more employees in its plan, costs rise. Handing out a match to 50 percent of your employees costs a whole lot less than giving that match to 90 percent. It's one thing to expect (or hope) a firm flush with record earnings would be willing to absorb that cost. But who's got that right now?

Costly Unintended Consequence of Reform The 401(k) auto enrollment feature was part of the 2006 Pension Protection Act. It was, and is, a sound idea: Americans need to save more for retirement, so finding a way to nudge more of us into getting going would be a good thing. Firms that change their 401(k) plan from opt-in (employee must choose to participate) to opt-out (employee is automatically enrolled and must choose to stop contributing) see overall participation soar.

And that, somewhat paradoxically, is what could set all our retirements back a step or two. Here's what the study authors have to say:

"--while automatic enrollment is likely to achieve the goal of increasing pension coverage, it might also work against the principal goal of increasing retirement savings. The prospect of lower match rates may not only reduce employer contributions to workers' retirement accounts, but some research suggests that lower match rates might also lower workers' own retirement contributions."
There's also the hit to long-time plan participants: If your plan decides that after adopting auto enrollment it can't afford to maintain its current matching contribution, your match will fall. That is, you will pay the cost of the greater good: getting more of your colleagues saving for retirement.

This isn't the only unintended consequence of auto-enrollment. As noted in an earlier post, many employers that have instituted auto-enrollment set very low default contribution rates at just 3 percent, and haven't put in place an auto-escalation feature to push the rate up over time. That all but ensures participants will fall short of what they need for retirement.

Just more fodder for everyone -- and I do mean just about everyone -- who thinks the 401(k) needs a serious overhaul. What's telling is that auto enrollment is a new reform; it's not some vestige of decades-old regulation. The fact that a new reform is creating problems seems to be an argument against trying to fix the 401(k) by sending it into the shop for periodic tune-ups. What we need is a new model, period.