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Automatic Enrollment Is Hardly A Panacea


Auto enrollment is fine, as far as it goes. But once you're in the plan you still need to know how to make decisions.

Testifying before Congress on Wednesday, Fed chief Ben Bernanke spoke sparingly, but passionately, about improving financial literacy in the U.S. by offering courses in our schools-presumably in such areas as personal finance, economics and investing. Right on, Ben.

But he dropped the ball when asked what could be done to stimulate Americans to "save more" and prepare for their retirement years. First of all, "more" has no place in the discussion. To save more, you have to be saving in the first place, and Americans spend more than they make. The US has a negative savings rate.

Bernanke could have talked a lot longer about the need for financial education-not just in the classroom but at work too, where most of us who do put something away do it through a 401(k) or similar plan. In general, we are so ignorant of our options that companies have taken to enrolling employees without bothering to tell them-until, that is, they are already in the plan. Only then do they have the right to do what they want with their money. Inertia takes over, and very few choose to opt out of the plan.

Automatic enrollment has been hailed as the solution to our collective savings shortfall. By the end of this year roughly half of all companies that offer a 401(k) plan will automatically enroll new hires, up from just 7% in 2000. Asked Wednesday what could be done to prompt Americans to save, Bernanke's only specific advice was to encourage this feature. Not a bad thing, for sure. But this is hardly a panacea.

As you might expect, company-sponsored plans with an automatic-enrollment feature boast enviable participation rates. A Hewitt Associates study last fall found that the participation rate averages 90% at companies with automatic enrollment and just 68% at companies without automatic enrollment. The IRS first blessed the concept in 1998, saying it was O.K. for new hires and stipulating that anyone enrolled be given ample opportunity to say no thanks. Two years later the IRS broadened its approval to include existing employees and 403(b) plans for teachers and 457(b) plans for government workers.

This expansion is good news because these plans are a great deal. You pack away pretax dollars that grow tax-deferred, and 90% of companies match some part of their employees' contributions to boot. That's a gift.

Yet the trend is unsettling in some ways. Consider: the law requires that 401(k) savings by highly compensated employees be tied to the savings level at the rest of the company. So highly paid execs deciding to enroll everyone benefit nicely when their company's total savings go up. When the staff contributes more, those who can better afford it get to sock away more too.

There are substantial problems with automatic enrollment. In 70% of plans, a low-yielding (3% or less) money-market or stable value fund is the default investment, and just 3% of pay is the default contribution rate. Those are woefully low figures. If you're not paying attention-and that fairly describes anyone who must be forced into a 401(k) plan-you might assume that the company fathers have made wise decisions for you. They haven't.

Most people should be heavily weighted toward stocks and saving enough to capture the full company match. Automatic enrollment doesn't necessarily get them there. Hewitt found that most automatically enrolled employees remained at the default contribution rate, had less-diversified portfolios and were less likely to actively rebalance or make transfers within their plans.

There are other ways to encourage saving. How about tying a bonus to being in the 401(k) plan? Some companies have tried sending out dummy 401(k) statements to show how much money is at stake. Yet many firms still don't do the simple things, like allowing new hires into a plan on day one. Automatic enrollment is fine, as far as it goes. But once you're in the plan you still need to know how to make decisions. Maybe Chief Ben will get around to that part of the savings equation next time.
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