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Five Keys to Automatic Retirement Plans

Topics:Personal Finance

By: Margarette Burnett, Bankrate.com | 08 Jul 2009 | 02:00 PM ET

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Are you putting money into a 401(k) without even knowing it? Automatic enrollment plans allow an employer to take a portion of your paycheck and put it into a 401(k) on your behalf.

These plans gained popularity after the passage of the Pension Protection Act of 2006, which made it easier for employers to sign up workers. Employees don't even have to take any steps to establish an account.

"There are a lot of people who are nervous about making a 401(k) enrollment decision. If you ask them to enroll, they may never get around to doing so because they don't feel educated enough about their options," says Andrew McIlhenny, an executive vice president with Firstrust Financial Resources in Philadelphia.

Automatic enrollment jump-starts the employee's retirement savings program, McIlhenny says.

According to a 401(k) benchmarking survey issued by Deloitte Consulting LLP, 42 percent of 436 companies examined use the automatic enrollment feature in their company retirement plans. This is an increase of nearly 100 percent from the previous survey, says Glenn Sulzer, senior pension law analyst with CCH, a tax law information company in Chicago.

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Despite the savings benefits, participants should be mindful of how these plans affect their individual financial picture.

"A lesser-paid employee may not feel comfortable deferring even the minimum percentage of compensation," says Sulzer.

For anyone saving for retirement, here are five things to know about automatic enrollment 401(k) plans.

Contribution percentages often too low
Nothing is a substitute for educating yourself and planning for your retirement. That includes knowing how much of your money is being saved, and where it is going.

"Employees need to learn their automatic enrollment contribution percentage," says Gregory Karp, author of "The 1-2-3 Money Plan."

With these plans, default deferral rates are typically about 3 percent of compensation. That savings rate is better than nothing, but it's probably not enough to help people reach their retirement goals, says Karp.

"The danger of keeping the default rate is that you may think it's all you need to save, but what you may really need is to save 10 (percent) or 15 percent of your pay," he says.

Karp adds that if your employer offers a 401(k) match, you may not get the maximum matching dollars if the default savings rate is too small.

Default investment choices not always best
Participants also need to understand where their money is being invested. Automatic enrollment contributions are typically placed in a default account, such as a life cycle or target-date retirement fund. These plans are selected based on the participant's age, or the expected number of years until their retirement.

In other plans, contributions are placed in short-term accounts, such as money market funds, that aren't designed to offer aggressive returns.

Tom Ruggie, president of Ruggie Wealth Management in Tavares, Fla., says that default accounts usually represent a one-size-fits-all approach that isn't always good for the participant.

"Different employees have different risk tolerances and retirement goals," he says. "It's ridiculous to assume we need to give them the exact same accounts just because of their age."

Next: Salary Deferral May Increase Automatically...

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