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Your 401(k) Plan May Be Selling You Short

If you were auto-enrolled at a default rate of 3% of your salary, don't assume it was for a good reason

Is 3 percent some magical retirement savings number?

When companies with 401(k) retirement savings plans enroll new hires automatically, many set a default contribution rate of 3 percent of salary. Why not 4, or 5.5, or 6? Are companies saying you can afford to retire if you save just 3 percent of your salary a year?

Hardly. Less than 22 percent of large companies surveyed by Towers Watson even provided 401(k) participants with a suggestion about how much to save. Of the companies that did, 39 percent recommended 10 percent or more. Increasingly, retirement experts say 15 percent is more like it. 

While few plans dare set default rates that high, more are moving to 4, 5, or 6 percent. A few use 8 percent, including General Electric, which is tied at No. 13 on Bloomberg's interactive 401(k) ranking, and at least one company, Google, sets it at 10 percent. 

If your plan enrolled you at 3 percent, there is a reason. It’s just not a very good reason. Three percent may be the norm simply because it was used in an example the government gave to employers early on, said Rob Austin, Aon Hewitt’s director of retirement research. The other reason it’s common, he said: Plans mimic their peers.

Since most plans match employee contributions of up to 6 percent at 50 percent, anyone who’s kept their contribution at 3 percent purely out of inertia should bump it up to at least meet the company match. That may sound painful, but studies of plans that upped their default contribution rates from 3 percent to 6 percent found that people didn't abandon the plan. If you’re lucky enough to be looking forward to a raise, time the increase in your contributions to coincide with that, so the cash flow hit isn’t as painful or obvious.

If your plan has an auto-escalation policy, it will raise your salary deferral rate into the plan automatically every year, usually by 1 percent. Plans tend to stop those 1 percent increases when workers hit 6 percent. But as with the default rate of 3 percent, some companies have realized they may be sending the wrong message in suggesting that 6 percent of salary is enough to save for retirement. More companies are letting the cap rise to 10 percent or even 15 percent. It costs companies nothing, since after 6 percent employees have usually met the company match.

Some companies that work with Towers Watson are rethinking the psychology of the numbers they use in their plan, said Robyn Credico, defined contribution practice leader for North America at Towers Watson. When rejiggering plan designs, some are considering matching to a bigger number but spreading the match out over more years. That way people would presumably save more, since a lot of employees tend to save up to the match. For a company, offering 33 percent on a 9 percent match would cost the same as a match that pays 50 percent up to 6 percent. 

Those kinds of changes aren't happening quickly. No one wants to be first.

"Everyone is following each other, but they all are saying people aren't ready for retirement," said Credico. "The question is who will be the first to step outside the norm and change behavior." 

Correction: An earlier version of this article cited Boeing, rather than General Electric, as an example of a company whose plan has auto-enrollment at 8 percent.

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