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Automatic 401(k) options
5 Tips: How new automatic 401(k) investment options work.
August 2, 2005: 4:50 PM EDT
By Gerri Willis, CNN/Money contributing columnist

NEW YORK (CNN/Money) - More and more companies are offering new ways of 401(k) investing that will allow you to sit back and hit "autopilot."

While some employees may welcome the trend, you may want to think twice about whether you should vacate the driver's seat when it comes to your nest egg.

In today's 5 tips, we look at what kind of changes you may be seeing in your 401(k) and what you should watch out for.

1. Don't do it yourself.

Call it procrastination, disinterest or lack of means, but 30 percent of employees are not participating in a 401(k) program, according to Hewitt Associates, a human resources consulting firm. Under an automatic 401(k), these employees would have to actively opt out of a retirement package in order to not participate.

Automatic enrollment of new hires can boost the rate of participation to 85 percent, according to Bo Harmon of the Retirement Security Project at the Brookings Institution.

Why are companies so eager to care for your nest egg? If companies follow the rules they get tax breaks, according to Jules Lichtenstein of AARP.

To get these tax breaks, companies must adhere to Non-Discrimination rules. These rules specify that retirement plan offerings include all income-level employees. Automatic enrollment boosts participation among lower-income employees, who are the least likely to participate in 401(k) plans. Top execs can also get better retirement options when more employees are on board.

2. Jump on the automatic escalator.

Even if you are already enrolled in a 401(k) plan, you can use this automatic escalation feature. This automatically contributes a percentage of the employee's salary to the 401(k).

The typical default rate is 3 percent of your paycheck. When an employee gets a raise, a portion of that money is put toward the 401(k). At annual intervals, the contribution rate can be raised to 4 or 5 percent unless the employee indicates otherwise, according to Harmon.

3. Set it and forget it.

Everyone is on a different page when it comes to how they should save for retirement. About 63 percent of companies offer some type of lifestyle fund, says Hewitt Associates.

This allows a person to indicate how long they have until retirement and their income level. A risk tolerance level is calculated and the employee is automatically put into a lifecycle fund that reflects their retirement position. Usually the fund is tweaked every year, according to Harmon.

Along with lifecycle funds, companies also use broad index funds as a default option. In this case money is typically put into a money market account. While this is a very safe investment option, the returns are often low.

4. The effortless rollover.

Even as you leap out of the door on your last day of work, there are decisions you have to make about your 401(k). Today, those decisions can be virtually eliminated.

If you have an accumulated 401(k) balance of between $1,000 and $5,000 when you leave the company, and you do not make a decision about how to take the distribution, many plans will automatically roll over the balance into an IRA. This IRA investment is designated by the employer and is typically a stable-value fund, according to Lori Lucas of Hewitt Associates.

In the past, if you had less than $5,000 in your account, the plan could provide that you get a check. Due to recent changes in the law, only accumulated balances of $1,000 or less may now be distributed as a check from plans that provide these types of cash-outs.

5. Keep control.

It's your choice if you want to remain in the driver's seat. If you set your 401(k) on autopilot you could be squandering your investment opportunities.

Since there are no clear government regulations on how much liability companies have with employee retirement funds, many companies are playing it safe and investing in very safe default options, like money markets, according to Harmon.

The low rate of return on default options can dash your hopes of retiring on easy street. Sometimes the automatic 401(k) lulls employees into a false sense of security, according to Hewitt Associates.

It's also a matter of freedom. You may have fewer investment choices if you are automatically enrolled, says Emily Urbano of the TransAmerica Center for Retirement Studies.

If you are not automatically enrolled, you may have up to 14 investment options to choose from. When you are automatically put into a default investment vehicle, the choice is out of the employees' hands, Urbano says. Employees can actively choose other investment vehicles in order to get out of default mode.

And watch out for fees! Lucas says that there are a few cases where the employers default you into third party managed accounts where you have to pay a fee. Usually an employee will have to pay fees of up to 1 percent of the assets. You may also have to pay an extra brokerage fee if you want to continue to actively manage your own 401(k).

And what about our own market know-how? Automatic 401(k)s don't necessarily help people understand the functions of investing, says Scott Revare of online advisory service Smart401(k). This automation is keeping us lazy, he says.


Gerri Willis is a personal finance editor for CNN Business News and the host for Open House. E-mail comments to 5tips@cnn.com.  Top of page

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