The ultimate no-brainer way to boost savings
A new study quantifies the potential effects on worker savings of a soon-to-be-enacted 401(k) auto-escalation provision from the Pension Protection Act.
NEW YORK (CNNMoney.com) -- Companies will soon have more reason to do something fairly simple that could boost their workers' retirement income from 401(k)s by 50 percent or more - and workers won't have to do anything but stay out of the way.
Come January, certain provisions of the Pension Protection Act (PPA) will go into effect that will give employers added incentive to implement automatic enrollment and automatic "contribution-escalation" features for their 401(k) plans.
Companies would automatically direct pay from a worker's paycheck to his 401(k) plan unless he explicitly chooses otherwise. And companies would gradually increase the worker's contributions every year. If the worker doesn't choose his own investment plan, money would go into a type of fund selected by the employer and approved by the Department of Labor.
For workers retiring between 2030 and 2039, the benefits could be substantial, according to a new study from the Employee Benefit Research Institute (EBRI).
Low-income workers would see their retirement income from their 401(k)s grow by 130 percent relative to what they would have had if they weren't auto enrolled. Middle-income workers would see a jump of between 35 percent and 67 percent. And high-income workers would see a 13 percent increase.
The PPA guidelines would require employers to set employees' initial contribution rate at no less than 3 percent of pay and increase that amount by one percentage point a year until reaching at least 6 percent or up to 10 percent. Plus, employers would have to offer a specified level of company match.
If these guidelines are met, employers wouldn't have to submit their plans for discrimination testing - which essentially ensures that a company's highly paid workers don't benefit more from a 401(k) plan than its non-highly compensated workers.
In making his calculations, EBRI fellow Jack VanDerhei, a Temple University business school professor, assumed workers would maintain their contribution rates when they switch jobs and that their contributions and matches would be invested in a target-date retirement fund, which automatically adjusts a worker's portfolio into safer investments as he nears retirement.
Such funds are among those the Department of Labor has given a preliminary thumbs-up to, but it has not yet issued final approval.
Still relatively new, the success of 401(k) auto features will depend on how workers respond.
EBRI asked 456 workers at what point they would discontinue an automatic 401(k) contribution increase: 44 percent said they would stop in the 6 to 10 percent range and 3 percent would discontinue the increase immediately or before their first raise.
Auto features in 401(k)s are now most typically found at companies with 5,000 or more employees. "We're approaching 50 percent of large companies that have auto enrollment, and of those, approximately a third have auto-escalation, which is twice the number of those that had auto escalation last year," said David Wray, president of the 401(k)/Profit Sharing Council of America.
Mid-size and smaller companies are more likely to follow suit after they see how the auto features play out at large companies. "They want the large companies to work out all the glitches," Wray said.
They also want assurances from the Department of Labor that the default investments they choose for auto-enrolled workers are sound, well-diversified options.
In the meantime, if your employer doesn't offer automatic escalation, you can reap the same benefits for yourself by making sure you contribute at least enough to get the full match from your employer, bump up your 401(k) contributions by at least one percentage point a year, and maintain your contribution rate when you take a new job.