The Case Against 401(k) Automatic Enrollment

Automatic enrolling workers in 401(k) plans is generally viewed as a way to get more employees to save for retirement. Instead of requiring workers to sign up and make investment choices, employees automatically have a portion of their paycheck set aside for retirement. These involuntary investors must take action only if they don’t want to participate or disagree with the default investment amount or allocation. A 2006 law made it easier for companies to automatically enroll employees in 401(k) plans. Since then, more employers have been automatically enrolling primarily new employees in 401(k) plans. However, contrarian Punam Anand Keller, a management professor at Dartmouth College’s Tuck School of Business, cautions that automatically enrolling all workers in 401(k)s or similar retirement accounts makes workers less responsible for their retirement decisions and doesn’t help people figure out how much they will need for retirement. U.S. News asked Keller to explain why workers who are automatically enrolled still need to pay attention to their investments. Excerpts:

What’s wrong with automatically enrolling workers in 401(k) plans?

It makes people less responsible for their own retirement decisions. A lot of employees who are automatically enrolled may think that their retirement is taken care of. People should be thinking about how much they have and how it is invested. How many of them are actually following up and seeing whether they will get a lump sum or an annuity or whether they are invested in a target date fund? It doesn’t tell people how much they are going to need to save for retirement. There is no savings goal. Without a goal it is very very hard to change people’s saving behavior. It doesn’t emphasize the consequences of saving or not saving for retirement. We don’t do enough education about the consequences of not filling this gap. With automatic enrollment, a lot of employers feel like it is a silver bullet and they are cutting back on financial literacy programs and I think that is inappropriate.

Should all employees be automatically enrolled at the same rate?

The current defaults adjust for salary and raises, but we have to put employees in segments and customize plans for them. Also, should we be automatically enrolling everybody? Should a 55-year-old be automatically enrolled? Should we be automatically enrolling low income employees who have a lot of debt and who may be visiting pay day lenders? Should we be automatically enrolling women with the same defaults as men without regard for household income? Should we have automatic enrollment in companies where you are encouraged to own company stock? Why are we only automatically enrolling new employees and not existing employees? Should we create different defaults for companies with a lot of low wage workers? We need to strike a balance between financial literacy and automatic enrollment.

How could automatic enrollment be made better?

We can do some things. We can require people to provide their savings goals. We can have separate education seminars for the young and old and males and females. Females often don’t want to go because they feel they don’t know as much as males and will be embarrassed. Males, when they are with females, will pretend they know more than they do. They also have different motives for saving for retirement. Females feel they have more of a prevention focus and men have more of a performance focus. Female employees are more worried about outliving their husbands and they don’t want to say all this in front of their male colleagues. This makes it very hard to have a good conversation. Women need to save more and need to know more about accumulation than men do because they are going to live longer.

If you’re automatically enrolled in your employer’s plan, what do you need to think about?

The problem with automatic enrollment is you don’t have to make any decisions and people don’t have any idea about matching versus not matching and what the level of the match is. It’s a very paternalistic system. People just don’t want to think about it. Automatic enrollment was designed to be just one part of your retirement savings along with your pension and Social Security. People are also going to have to open supplemental retirement accounts and make decisions about how much to save and how to invest and how to track it. If you take some financial responsibility for your own decisions you will be much better at crisis management than if you were automatically enrolled because you have some ability to know what is going on.