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Is Your 401(k) Set Up To Fail? Here's How To Fix It

Is your employer blindsiding you with your 401(k)? You might think you're on track to retirement because your company enrolled you in the plan automatically. What they didn't say is that they set you up to fail. Auto-enrollment has been a great step forward, because it catches people who otherwise wouldn't save. But, left alone, your contributions won't build a nest egg even close to what you'll need.

Who besides you will care if you run out of money when you retire? "Your children will," says Alicia Munnell, director of the Center for Retirement Research at Boston College. Already, Baby Boomers complain about being a "sandwich generation," busy taking care of kids and aging parents, too. If the Boomers themselves retire broke, they'll stress family support systems to the breaking point. "We're generations away from the time when taking in parents was a social norm," Munnell says. For Boomers' children, "it would come as a major shock."

When you take a job at a company with a retirement plan, you're asked two things: How much of your paycheck do you want to contribute to savings, and which of the mutual funds in the plan do you want to invest in?

If you can't decide, nearly half of the large plans now enroll you automatically, usually in a combination of stock-and-bond mutual funds. You can opt out if you don't want to save, but most people stay in. Some 401(k)s also enroll existing employees who didn't join the plan before. So at least you're putting something away.

But how much? That's where the companies fall down. What you're saving might amount to little more than lunch money, according to a new survey of large plans by the Defined Contribution Institutional Investment Association (DCIIA), which represents plan professionals.

The DCIIA recently collected data for 101 large plans. Forty-four of them enroll new hires in the 401(k) automatically. Of these, a majority set you up to save only 3 percent of pay. If you earned $60,000, you'd be saving just $150 a month toward a retirement that might last 30 years. A number of plans set your contributions even lower.

Such small amounts aren't anywhere close to what the sponsors in charge of the plans would recommend. Eighty-seven percent of them said that you should put aside 10 percent or more of pay. So they know what they ought to be doing for their employees -- they're just not doing it.

You can raise your contribution voluntarily just by telling your company to do so. But many people who accept automatic enrollment probably assume that the level the company chose was the right one. Or they pay no attention, riding with whatever they've got.

You might say "tough luck, it's your own fault if you end up poor." But the data show that large corporations are rethinking that approach. The majority of them "want their employees to get the most out of their plans," says Cathy Peterson, the DCIIA report's lead author and a vice president at J.P. Morgan Asset Management. That's why they're auto-enrolling. They know it might be the only retirement plan you have.

For a better future, however, you not only have to start with higher contributions, you also need to raise the amount you save each year. Here, too, automatic 401(k)s aren't yet stepping up to the plate. Of all the plans with auto enrollments, only about one-third also increase your contributions automatically and, in most cases, only by 1 percent a year. For a $60,000 earner, that's an extra $50 a month -- about the same as bus fare. Employers think that anything higher might not be "palatable" to their employees, DCIIA reports.

But there's zero evidence that you'd opt out of a 401(k) if it took more out of your paycheck for retirement savings. A few companies start you out at as much as 10 percent of pay, with no worker revolts.

Automatic enrollments should start with contributions of at least 6 percent, in the opinion of DCIIA. Those amounts should rise automatically by at least 2 percent a year, to reach 10 percent as rapidly as possible.

If you're deciding on your own contribution, treat the DCIIA's formula as the minimum. Even better, start with 10 percent. If your company offers automatic increases, sign up. If not, increase the amount yourself each year. The maximum dollar amount you can contribute in 2011 is $16,500, plus an extra $5,500 if you're 50 and older.

Improving 401(k)s is just part of the effort needed to raise retirement savings. Only about half the population has access to a workplace plan. For the other half, there are Individual Retirement Accounts, but no more than 10 percent of eligible working people start one, due to inertia, impediments to finding and choosing a plan, and uncertainties about making investments.

To help solve these problems, retirement experts on both sides of the liberal/conservative line support legislation creating private-sector, automatic IRAs. Companies that don't offer pensions or 401(k)s would be required to enroll their new hires in Roth IRAs, which accumulate tax free. "There should be no significant cost," says Mark Iwry, senior advisor to the Secretary of the Treasury. "A temporary tax credit would defray whatever costs there are."

Employees could pick their own IRAs or the employer could pick them -- say, choosing the suite of mutual funds offered by their current banking partners. For small contributions, a savings bond option might be provided. Money for automatic IRAs comes entirely from employee paychecks, the businesses don't contribute a dime. There's an opt-out for employees who object.

Bills to create automatic IRAs have been introduced three times, by Sen. Jeff Bingaman (D-NM) and Rep. Richard Neal (D-MA). The two previous versions has Republican co-sponsors, but last year the GOP dropped out. Small-business lobbyists are dead against. In focus groups and surveys, however, small business owners tend to like the idea, once they understand it, Iwry says.

Studies by the group Retirement Made Simpler, advised by David John of the Heritage Foundation, shows that well over 80 percent of workers who were enrolled automatically in 401(k)s are grateful for it and started saving earlier than they otherwise would. But the portion of companies offering 401(k)s hasn't risen significantly for years.

For the tens of millions of workers currently outside the system, automatic IRAs "promise to create a breakthrough, by providing easy access to savings," Iwry says. Small employers are no less concerned about workers than large employers. This could be the savings benefit that works.

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