Posted on 17 February 2010
By Mark Miller
On long driving trips, I love to use cruise control. I just set the speed once and stop worrying about how fast I’m going. Of course, I still need to steer, and watch out for other drivers.
Automation can be good for retirement saving, too–but only up to a point.
Employers have been adding more automatic features to their retirement plans ever since the Pension Protection Act became law in 2006. Some of that law’s provisions aimed to boost participation in workplace retirement plans by encouraging employers to enroll new workers automatically in retirement plans, and by making it easier to offer target date funds, which rebalance portfolios to a more conservative stance as retirement dates approach.
Automatic features began gaining ground immediately. About half of companies that offer defined benefit savings–mainly 401(k)s–now auto-enroll their employees, and one-third of those that don’t are thinking of adopting it, according to a survey by Towers Watson, the employee benefits consulting firm. Ibbotsen Associates reported that assets in target funds hit $256 billion at the end of 2009, up from $159 billion at the end of 2008.
Employers are worried about the ability of their employees to save for retirement. Hewitt Associates reports that 80 percent of companies that suspended or reduced their 401(k) matching contributions in 2009 plan to restore them this year. Hewitt’s survey also found rapid adoption of other automation features, including automatic portfolio rebalancing and automatic contribution escalation. A growing number of employers also are adding online investment guidance for employees or managed account options, which allows employees to turn over investing to a money management professional.
These are positive developments. Automatic enrollment has boosted participation rates, and target date funds can eliminate dangerous asset allocation errors made by consumers, who tend to stay overweight in riskier equities as retirement nears.
So, automation has the potential to boost retirement security for millions of Americans. But if you’re in a plan offering these features, don’t assume automation alone will get you to the destination of a secure retirement without some manual driving on your part.
For example, the default initial contribution rate is too low in most plans featuring automatic enrollment–a median of 3 percent, according to the Towers Watson survey. That’s not enough to build real retirement security; a person who starts saving at age 40 should be socking away about 15 percent of annual income in order to retire comfortably at age 65. At minimum, employees should try to set their rates high enough to match the employer’s top matching contribution.
And 23 percent of these automated plans default employees into risk-averse balanced funds–an inappropriate choice for young investors who have many years to work before retirement and can tolerate a more aggressive approach.
“Automatic enrollment is a pretty good way to get people to start saving, but employers need to be careful how they do it,” said Robyn Credico, senior retirement consultant at Towers Watson, the employee benefits consulting firm. “If plan sponsors aren’t enrolling their employees at a high enough rate of savings and just use the plan’s default investment options, you aren’t really preparing people very well.”
Target date funds were criticized after investors suffered large losses in the crash of 2008. Some funds tailored for close-to-retirement investors fell as much as 50 percent, according to Morningstar, prompting criticisms that fund investment mix had been too aggressive. Fund sponsors point out that target funds don’t guarantee return, and many have stuck with relatively aggressive equity holdings during the market’s recovery.
The Obama administration’s recent Middle Class Task Force report called for target date fund reforms aimed at boosting transparency and investor education about how these funds work.
“Participants don’t always understand target date funds,” says Credico. “Employers are doing more now to communicate that target funds don’t offer a guarantee–it’s just a balancing technique.”