Automatic-Enrollment 401(k)s Have This Danger
NEW YORK ( MainStreet) -- Automatic-enrollment in 401(k) plans is a mom-and-apple-pie idea, supported by just about everyone from the president to academics who study retirement issues. But it turns out there's an unintended consequence: companies that adopt it often get stingier with matching contributions .
That's the finding of a study by the Center for Retirement Research at Boston University. While auto-enrollment does benefit employees who otherwise wouldn't bother to participate in their firm's 401(k), lower matches hurt all the participants.
The cuts in matching contributions are not big, just a fraction of a percentage point on average. But they show that companies pressed to adopt auto-enrollment could become reluctant to raise matching contributions, something many retirement experts would rather see.
A plan with auto-enrollment automatically signs up new employees, setting aside a given percentage of their pay for the 401(k). Employees have the right to opt out, but experience shows that once enrolled many stick with the plan. They also can raise their contributions.
Auto-enrollment has been growing in recent years, promoted by government policy and the plan industry, including fund providers such as mutual fund companies, as a way of building retirement security. Many retirement experts say it's essential to boost 401(k) participation because fewer and fewer workers have old-fashioned pension plans.
But when more employees participate, a company that makes matching contributions has to put more money into the plan. Not all employers match, and matching policies vary widely, but many firms contribute 50 cents or a dollar for every dollar put in by the employee. Typically, matches are capped at 3% to 6% of the employee's pay.
The BU study, covering thousands of plans, found that auto-enrollment does indeed raise the average employee participation rate -- to 77% from 67%.
The maximum match averaged 3.2% of pay for firms with auto-enrollment, compared with 3.5% for those without it, a statistically significant difference, according to the study's authors.
The authors also noted that the initial employee contribution rate set in auto-enrollment plans fell well short of the contribution needed to get the employer's maximum contribution. An employer that really wanted workers to contribute as much as possible would set that "default" contribution rate higher.
Since the default contribution comes out of the employee's pocket, not the company's, these low default rates could be a way of minimizing the employer's cost of matches. Of course, it's also possible employers worry that a very high default rate would scare off potential hires.
So what does it all mean? The authors note that many auto-enrollment policies are fairly new, and that more study is needed. But the results do suggest that cost concerns can keep employers from pushing hard for higher 401(k) participation.