Putting Your 401(k) on Autopilot
By Ellen Hoffman
Numerous studies have documented the failure of 401(k) participants to save enough money for a comfortable retirement. A recent case in point: a report from Alicia H. Munnell and James G. Lee of the Boston College Center for Retirement Research. Among their findings: That in 2001, the median 401(k) IRA account balance of individuals nearing retirement (ages 55-64) was $42,000, that 25% of eligible workers choose not to participate in 401(k)s, and fewer than 10% of participants contribute the maximum.
A possible solution for creating more robust nest eggs is what's known as the "autopilot" 401(k). If you sign up for one of these plans, certain decisions related to your 401(k) will be made automatically, meaning you shouldn't have to review and reassess your investment vehicles and contribution levels as often. Vendors such as Vanguard Group and Principal are already pitching autopilot accounts to employers, and others will likely follow.
Even if you're already enrolled in a 401(k), your employer may soon offer autopilot features. There are four basic elements: automatic enrollment, automatic increases in contributions, automatic investing, and automatic rollovers or retirement withdrawals. Not every plan will offer all features, and the details will vary depending on which one your employer offers. Here's a guide to helping you understand the various features and the possible implications of setting your 401(k) on autopilot.
• Enrollment. A new employee is enrolled in the company's 401(k) unless he or she opts out by a certain deadline. This feature has been around for a while. It was offered in about 8% of all 401(k)s and in 25% of plans with more than 5,000 participants in 2002, according to the Profit Sharing Council of America, a trade group for plan sponsors.
• Increasing your savings rate. This is the second autopilot element, and it's newer. To ramp up her retirement savings, Robin Amsahar, 42, who works in sales support for an electrical distributorship in Cedar Rapids, Iowa, has opted to increase her 401(k) contributions by 1% a year for each of the next four years. The option, known as Step Ahead, is part of the 401(k) plan created by Principal for her employer. A slightly different approach is available through Vanguard's One Step program, which ties automatic contribution increases to salary increases.
• Investing. You implement the third autopilot element, which is investing, by agreeing to put your contributions in mutual funds that the plan administrator selects and shifts as you approach your retirement date. Vanguard offers six products -- actually funds of funds -- with different asset mixes. For example, the recommendation for people who plan to retire in 2025 is 60% in stock funds and 40% in bond funds. For those who want to retire in 2015, the mix is 50-50.
• Automatic rollover. The fourth autopilot feature is designed to stanch the outflow of money from retirement accounts when people change jobs or retire. Munnell and Lee report that 55% of those who change jobs cash out their retirement accounts, losing the benefit of long-term compounding within the tax-deferred account. And if they're younger than 59½, expect to pay income tax in addition to a 10% penalty on the amount withdrawn.
New retirees tend to take their money in lump sums, often not thinking about asset allocation, says Bert Dalby, a principal at Vanguard. The automatic rollover feature of Vanguard's plan and others ensures that the money goes into funds -- whether still in the 401(k) or an IRA -- chosen because their appropriate asset mix. If you're switching jobs, the sum would be invested differently than if you're retiring, when the emphasis is on investment designed for retirement income.
If you're offered a plan with autopilot features, should you sign up? As with any investment, ask about any fees you'll have to pay and compare them with your current plan's fees. Mark Iwry, senior fellow at Brookings Institution, advises stepping back and analyzing how well you've done with your current 401(k) or without a retirement savings account.
Will you meet your savings goals with your current savings rate and investment choices? Are you committed to reviewing your account on a regular basis -- twice a year, say -- and raising the contribution rate or taking the trouble to rebalance your portfolio in order to maintain good asset allocation? Or would you rather someone else make the decisions for you?
READ THE FINE PRINT.
If you're inclined to go on autopilot, a couple of caveats are in order. Iwry points out that "there's the risk that some folks who are contributing more and investing better [than the default contribution and investment levels] will be lulled into a lower contribution level and a worse investment pattern" by going on autopilot. This could happen if you don't read the fine print and make careful comparisons with what you're doing now. As with any 401k, the plan sponsor has fiduciary responsibility under federal law to make prudent decisions, operate the plan in the interest of the participants, and to monitor those plans.
Nevertheless, if it's too easy to leave the management of your 401(k) to someone else, your savings could be going downhill for some time before you realize it. Just because the word "automatic" is invoked, don't count on always getting the returns you want. Like any other investment, it will be subject to market fluctuations. Both Vanguard and Principal allow you to withdraw from the program at any time, either online or with a phone call.
One more warning: Most people work for several different employers in a career. Even if your previous employer lets you leave the money already accumulated in your autopilot 401(k), you could still end up doing paperwork and having to monitor your other retirement accounts. But that beats not having assets to worry about! And thanks to autopilot programs, fewer retirees may find themselves in that situation.
In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site, www.retirementcatchup.com
Edited by Patricia O'Connell
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