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401(k) Auto Enroll, Deferral Not Enough

Last year's Pension Protection Act went a along way toward potentially boosting the number of Americans saving for retirement, but if employers want their workers to truly be prepared, they've got to get aggressive, according to a brief published by the Employee Benefit Research Institute of Washington.

The report discounts the concept that the shift from defined benefit to defined contribution plans has actually shifted the responsibility of preparing for retirement from the employer to the worker. In fact, with automatic enrollment, the role of the plan sponsor is as critical as ever.

"Plan sponsors are paving the way," said Jodi DiCenzo founder of Behavioral Research Associates in Evanston, Ill., and author of the EBRI brief.

And the biggest threat to an employee's security in retirement may not be their own inertia anymore, but, rather, that of the employers sponsoring 401(k)-like plans, she said.

To truly help their employees, and fulfill their role as fiduciaries, she said, employers must design defined contribution plans that use employees' tendency to follow what she calls "the path of least resistance" not only to enroll workers, but to use higher default rates, increase their contributions over time and invest them in funds that perform as close to the markets as possible.

For mutual fund companies that can create cost-effective, open-architecture funds, the opportunity is enormous, according to Karen Remmele, senior analyst with Boston-based Cerulli Associates, but it's going to take time. "It will take a while before plan sponsors fully grasp this," she said.

"Plan sponsors still play a very critical role. They're still making very important decisions," DiCenzo said.

Among those decisions is how much employees who are automatically enrolled into retirement plans should contribute.

401(k) Inertia

Study after study has shown that employees who are automatically enrolled in defined contribution or 401(k) plans tend to stay put. In fact, DiCenzo cites a 2001 study by Brigite C. Madrian and Dennis F. Shea that shows when automatic enrollment is implemented, participation typically jumps from 37.4% to 85.9%.

Likewise, employees tend to stay enrolled at the rate their employer chose. Seventy percent of those enrolled stayed at 3%, and left it all in the default investment vehicle, a money market fund, according to the study.

Even employees who attended informational seminars-a proactive step-and said they intended to increase their contributions, never did, according to another study DiCenzo cited.

After two years, 40% of employees continued to save only 3%, despite employer-offered matching incentives.

A 2006 survey of plan sponsors by Deloitte Consulting suggests that such trends will only be amplified as automatic enrollment continues to catch on. In fact, 79% of those companies surveyed by Deloitte that implemented automatic enrollment started them at 3% or less.

"No matter what the default rate plan sponsors select, they probably won't select a rate initially that will get workers to where they need to be," DiCenzo said.

Her paper suggests starting employees saving at 5% or 6%, and designing the plan so that contribution rates get ratcheted-up annually.

While higher defaults, and therefore higher inflows, may please plan providers, employers have to be careful to find the right balance for their employees, said Donald B. Trone, founder of Fiduciary360, a consultancy based in Sewickley, Pa., that specializes in helping fiduciaries find best practices.

"Three percent won't get us to the numbers, but 6% might cause backlash," he said. And if employees feel that their retirement is taking too big a chunk of their budgets, or that their employer is being too despotic, they are more likely to withdraw from the plan altogether, defeating the initial goals of auto enrollment.

Close to 90% of 401(k) plans, Trone noted, have less than $1 million invested, and for every employee who chooses not to contribute, the administration cost per worker goes up.

"The danger is plan sponsors simply saying it's not worth offering a retirement plan," he said.

When it comes to investment options, selecting the right choice for employees is not only a business decision; it's a legal imperative. Fearing lawsuits slamming them for taking risks with their workers' money, most plan sponsors who use automatic enrollment choose stable value, typically money market funds, as the default, Trone noted.

Not only does this hamstring long-term participants who stick with the prescribed allocation, but it might actually open sponsors to claims that they breached their fiduciary responsibilities by not doing enough for their workers.

"If a plan sponsor says they put the money in a money market fund because it could never go down and it minimizes the risk of being sued [by participants], I say, you just put your interest ahead of [your employees]," said Brooks Hamilton, founder of Garland, Texas-based retirement plan consulting firm Brooks Hamilton & Partners. "That is the classic definition of breaching your fiduciary duty," said Hamilton, who is also an attorney and expert in ERISA law.