Automatic enrollment in 401(k) plans has become increasingly widespread with employers who offer such plans; in fact, more than half of all 401(k) plans now use automatic enrollment. While this system does encourage employees to save for retirement, it comes with some potentially serious drawbacks.
Why automatic enrollment?
Faced with extremely low participation rates in 401(k) plans, employers have tried to improve the situation by using automatic enrollment for employees. Essentially, instead of having to opt into a 401(k) plan, employees have to opt out. If they don’t opt out, the employer will automatically start taking contributions out of the employee’s paychecks at a predetermined (usually low) rate and putting them in the default 401(k) investment option, often a target date fund.
The good news
While automatic enrollment contributions are universally low, employers will usually set them at a level that will max out company-matching contributions. That means employees on the automatic enrollment plan won’t be missing out on any free money. And while saving such a small amount won’t be enough to fund anyone’s retirement, it’s better than nothing.
The bad news
Too many employees assume that by not opting out of the automatic contributions system, they’re doing all they have to do to prepare for retirement. This false sense of confidence means that such employees are less likely to draw up a retirement plan and calculate how much retirement savings they’ll really need. As a result, automatic enrollment plans tend to increase employee participation but decrease the amount of contributions overall. And automatically enrolled employees are more likely to just leave their contributions in the default investment option, even though it might not be the best choice for them.
Take it to the next level
Enrolling in your 401(k) is only the first step — not the be-all and end-all of retirement saving. If you remember that important truth, than automatic enrollment can have a positive effect on your retirement planning because it gets you going with your 401(k) contributions. However, don’t procrastinate on the next step: namely, figuring out how much you actually need to contribute (hint: the 3% automatic contribution your employer set up for you won’t be enough). And you’ll want to find out what your other investment options are to see if one of them would be a better fit than the default fund.
Finding your magic number
The best way to figure out how much money you’ll need to retire is to add up your probable expenses, calculate how much income you’ll need for those expenses, and use that to determine the total sum. If you don’t want to take the time to come up with a full-scale retirement plan, you can use one of the quick-and-dirty methods: use your annual salary times ten as the total you need to save, or use 80% of your current income as your minimum retirement income and use a retirement calculator to figure out how much savings you need for it, or just contribute 15% of your paycheck and call it good enough. Any of these methods will get you in the ballpark, although you should definitely do a more customized calculation in the future.
Evaluate the options
401(k)s typically don’t offer as many investment options as IRAs do, but there will usually be at least a handful to choose from. These days the default option is usually a target date fund, chosen with an eye to what HR thinks is your most likely retirement date. If you plan to retire either on the early side or the late side, then shifting to a different target date fund is critical. Or you may prefer to abandon target funds altogether and take a more active role in choosing your retirement investments. If you choose to shun target funds, consider choosing at least one stock fund and one bond fund, allocating your contributions by subtracting your age from 110 and putting that percentage of your money into stocks. For example, if you’re 25, then 85% of your retirement contributions should go into stocks and the other 15% into bonds. Whatever you choose, don’t forget to check the expenses and fees that are associated with each fund.
Give them an annual checkup
At least once a year, take a look at your 401(k) statement and see if you need to make any changes. For example, if your stock fund has outperformed your bond fund or vice versa, you’ll need to rebalance your investments to get back to that 85/15 percentage of stocks versus bonds. If you stuck with a target date fund you won’t need to rebalance, but you should keep an eye on how well the fund is performing — if you’re getting disappointing returns, consider moving to a different fund instead. The whole process should take no more than 15 minutes or so. That may not be as hands-off as letting the automatic enrollment system do the work, but ensuring a comfortable retirement is well worth 15 minutes a year of your time.
The Motley Fool has a disclosure policy.
This Article Was Originally From *This Site*