Monday, January 29, 2007

An Automatic Boost for Your Nest Egg

News Analysis
January 29, 2007

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An Automatic Boost for Your Nest Egg

More and more retirement plans have been adding automated features. Now big providers are launching new ways to boost savings by default

The next revolution in retirement savings may be taking place without your even knowing about it. With the "automatic" features increasingly cropping up in workplace retirement plans, the point is that you don't have to.

Over the past few years, employers have turned to new 401(k) programs that aim to make smart savings habits the default option. More recently, retirement plan vendors have started introducing what could be a new generation of automatic savings options.

So-called "autopilot" 401(k)s make certain decisions for employees by default. For a while now, some employers have embraced automatic enrollment, which means they sign new employees up for the company retirement plans unless the worker opts out (see, 4/25/05, "A Nest Egg That's a No-Brainer"). In 2005, 16.9% of companies sponsoring 401(k) plans offered automatic enrollment, including 34.3% of companies with more than 5,000 employees, according to a survey by the Profit Sharing/401(k) Council of America.

Other hands-free features, like automatic contribution increases and even automatic investing, have also arrived in the 401(k) market (see, 10/8/04, "Putting Your 401(k) on Autopilot"). Such programs are based on behavioral research showing that workers typically take the path of least resistance when it comes to retirement—even when it's against their best interest.

"Auto-Everything" Plans

Now, a new set of automatic functions could be making its way into your company's retirement plan. T. Rowe Price (TROW) recently introduced a feature, dubbed "auto-boost," that would raise all employees' contribution rates up to the maximum employer match. Meanwhile, Fidelity is exploring a feature that would go even further, lifting contribution rates for employees age 50 and older to the Internal Revenue Service limit for "catch-up" contributions.

These new features are the latest phase of a trend toward giving 401(k)s some of the "do-it-for-me" advantages of pension plans. "It's auto-everything at this point," explains Ron Bush, managing principal of West Hartford (Conn.) research and consulting firm Retirement Resources. "Now we're talking about getting people to the point where they're contributing at least up to the company match, and hopefully beyond."

A catalyst behind the most recent changes is the Pension Protection Act, passed by Congress in 2006 (see, 8/18/06, "Deciphering the New Retirement Law"). The law made automatic enrollment and automatic contribution increases more attractive for employers. It also made the higher 401(k) and IRA contribution maximums passed in 2001 permanent.

Full Company Match, Pronto

"Congress explicitly placed a priority on helping employers use the path of least resistance to get more workers to participate in 401(k)-type retirement plans, where one is offered," says Jodi DiCenzo, founder of Evanston (Ill.)-based Behavioral Research Associates, in a Jan. 16 report for the nonpartisan Employee Benefit Research Institute.

T. Rowe Price's new auto-boost option puts a more dramatic spin on existing automatic features. The program, due to go fully live at the end of the first quarter, allows employers to bump up their workers' contribution rates so they qualify for the full company matching contribution, says Rachel Weker, vice-president for product development at T. Rowe. Workers receive information about the change beforehand and may opt out.

Automatic contribution increases have been available for some time from Fidelity, T. Rowe, Principal (PFG), Vanguard, and other 401(k) providers. T. Rowe's new feature differs by boosting participants' contribution rates to the company match in one fell swoop, rather than raising them gradually over time.

Catch-Up Made Simple

"Automatic enrollment was getting people in at the minimum, and in a lot of cases that wasn't enough to maximize employees getting their company match," Weker says. "We think auto-boost is going to get people to where they should more likely be."

Fidelity's new 401(k) feature stems directly from a provision that was made permanent in last year's legislation. Under IRS rules, workers may contribute up to $15,500 to a 401(k) in 2007. Workers 50 and older are also entitled to make catch-up contributions of up to $5,000. However, this favorable treatment of catch-up contributions was previously set to expire in 2010. The Pension Protection Act changed that.

In light of the new law, Fidelity is testing a feature that lets employers automatically increase older workers' contribution rates until they reach the maximum catch-up amount. "This is an evolution of the auto increase program, to make sure all participants are taking full advantage of this new savings feature that became permanent as a result of the PPA," says James Cornell, senior vice-president for employer marketing at Fidelity.

Win-Win for Providers and Employees

The new feature could have widespread implications. As of 2005 more than 90% of qualified retirement plans administered by Fidelity offered the catch-up provision, according to the firm. However, just 9.8% of employees eligible to make catch-up contributions were doing so.

Automatic contribution increases could be a smart way to improve workers' chances of saving enough for retirement, financial advisers say. "I am strongly in favor of automatic everything when it comes to financial planning and investment management for employees in the workplace," says John Vyge, senior financial planner at Dulles (Va.)-based Hillebrand Financial Planning. "Otherwise people don't or won't do it, usually due to either procrastination or lack of knowledge."

Of course, higher contribution rates also benefit companies like Fidelity and T. Rowe, which charge fees based on assets. Still, retirement plan automation may be an instance where business interests and the public interest converge, industry experts say. "It's not altruistic, but in the end it's absolutely the right thing to do," says Fred Barstein, president and CEO of Greenacres (Fla.) marketing research company 401kExchange.

Autopilot 401(k)s may lack sex appeal, but their rise might increase the odds of a secure retirement for people who lack the time or inclination to become expert investors. If your retirement can't be guaranteed, at least it could be automatic.

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