The truth is that most of us are more likely to increase the amount of money we’ll commit to socking away in a 401(k) plan from year to year—and stick to our guns about regularly accelerating the savings rate— if the decision is made ahead of time.
Most people need to get their 401(k) contribution rates into the neighborhood of 15% a year or more in order to properly finance their retirement. And yet, of us will not devote the time and effort needed to move us beyond the paltry 3% rate some of us enroll at, unless a systematic increase is put into place allowing those deferral increases to happen automatically.
The Psychology of Retirement Saving
It’s been proven, in fact, that inertia (our tendency to do nothing when it comes time to read retirement savings literature or contribute more to our accounts) is more powerful than the threat of poverty in old age. That’s why an automatic acceleration or “set it and forget it” regime can work very nicely to encourage higher 401(k) savings rates.
Fortunately, inertia can also be used quite successfully to keep people saving at higher rates year after year, according to a 2004 paper co-authored by two behavioral psychologists, UCLA professor Shlomo Benartzi and University of Chicago professor Richard Thaler.
New research, including that done by Harvard University economics professor David Laibson, shows that employees are apt to be as happy with a 5% to 9% default as they are with the more traditional 3% or 4% default. The lower rate “is just not enough to save for retirement,” he says.
Today, more and more employees with existing 401(k) plans or newly founded programs will find it possible to take matters into their own hands. Programs allow them to automatically increase their plan contributions by 1% or more each year.
“Most major retirement plan vendors now have a feature allowing plan participants to sign up for auto-increase on their own,” explains retirement plan expert Steve Dimitriou, an accredited asset management specialist and managing partner with Mayflower Advisors LLC in Boston.
Although Dimitriou has found employees reticent to adopt automatic features, he sees that trend shifting as more and more plan vendors push these features as a way to pull in more assets. Some retirement plan companies are even going so far as to offer a pricing discount if companies adopt automatic enrollment and acceleration features.
Catching on With Employers
More than 50% of employers at larger companies with at least 5,000 employees adopted both auto-enrollment and auto acceleration for their retirement savings plan this year, according to a 2009 study by Hewitt Associates. Which goes to show that at most larger firms you will automatically become part of the plan and see your contribution increase automatically unless you actively “opt out” by signing a document.
Is that a good thing? If you are aware of how your 401(k) money is invested and are willing to monitor your performance over time, then the answer is yes. The concept in question is meant to work over the long-term, but opting out of auto increases is always an option, should market conditions make you wary of investing even another cent in your 401(k) next year. On the other hand, auto-acceleration may not be your thing, and you may want to look into a target date fund or a managed account option where professionals make decisions over time. Keep in mind, however, that all of these options come with risks.
Key Points to Consider
If auto-acceleration sounds like it might work for you, here are some words to the wise:
Keep in mind that your employer may make the initial determination of how much the automatic increase will be, how often it will be triggered and whether there will be a cap on total savings—10% or 15% of one’s paycheck, for instance.
There should always be an opt-out for participants. If you have signed up for the standard, automatic increase for next year and suddenly decide you want to call it quits, you should be able to sit down at your computer and flip a switch to turn the increase mechanism off, or change it to a different level.
Make sure you know the particulars of your own plan. Ask the folks in human resources if they have an 800 number for the plan vendor or another source of information if it the details aren’t entirely clear.
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