Put your 401(k) on AUTOPILOT

Author: Mary Beth Franklin

Published: October 2005

After more than 20 years of trying to educate, encourage and advise employees about how to save for a secure retirement, some employers have rolled out a new answer: the autopilot 401(k). The automatic 401(k) relieves workers of many investment decisions and puts them on the road to a more affluent retirement. When Genesis HealthCare Corp began offering a managed-account option last year, Cheryl Parson, 54, was quick to sign up. After 18 years of contributing to the company's 401(k), she was thrilled to have a professional take over the investment decisions. She enrolled online in the Wachovia Advice Track program and answered some questions about her age, retirement goals and risk tolerance. The program includes 12 mutual funds, and the managed-account services costs 1.2% to 1.3% of assets each year. Since Advice Track arrived last August, enrollment has jumped by more than 10%, and three-fourths of those who signed up are having their contributions increased automatically by 1% a year.

Make retirement investing less mind-boggling and more profitable? What a concept!

TALK ABOUT A disconnect: Just as President Bush ramps up his fight to allow Americans to take charge of investing part of their social security taxes in private accounts, an increasing number of workers are pleading to be relieved of making investment decisions in the 401 (k) accounts they already have. The old plea of "Tell me what to do with my money" is giving way to "Please do it for me."

Plan sponsors are listening. After more than 20 years of trying to educate, encourage and advise employees about how to save for a secure retirement, some employers have rolled out a new answer: the autopilot 401(k).

"For so many years, we focused on educating people about investments but lost track of the need to tell them how much they needed to save," says Carol Geremia, president of MFS Retirement Services in Boston. "This isn't brain surgery, but sometimes we make it seem that way." The best way to save for retirement is to start early and "save until it hurts," she says. Like so much indisputable advice, it's much easier said than done.

"It's exciting that employers are beginning to understand how important it is to keep this simple and make it automatic," says Geremia.

As retirement plans have shifted away from traditional pensions and toward a do-it-yourself approach, investment decisions-and risks-have moved from professional investors to individual plan participants. In 1981, nearly 60% of workers who were covered by a plan had a traditional pension, where their employer contributed money on their behalf, made all the investment decisions and promised pension checks for life. Fewer than 20% of workers had a 401(k) as their only form of retirement savings. Two decades later, the tables had turned. The percentage of workers covered only by a 401(k) plan was nearly 60% in 2001, while those covered only by a traditional pension slipped to 10%.

The 401(k) plan came with a new set of rules: Individuals first had to decide whether to participate-and accept less take-home pay to do so. Then they had to figure out how much to contribute and decide where to invest the money. Some workers have thrived, amassing sizable nest eggs in the process. But others have stumbled, jeopardizing their future financial security.

"Three key components of retirement readiness are participating in workplace retirement plans, maximizing salary-deferral rates and maintaining proper asset allocation," says Bill Carey, president of Fidelity Institutional Retirement Services Co. "Unfortunately, many American workers may feel either unprepared or uncomfortable making these critical decisions." And, to be fair, they aren't easy decisions to make.

The new model

THE AUTOMATIC 401 (k) relieves workers of many of the decisions and puts them on the road to a more affluent retirement. With most 401(k)s today, the employees have to opt in by signing up for the plan. With an automatic 401(k) plan, you're in unless you specifically say no. An initial contribution amount-such as 3% of salary-goes to an appropriate investment, such as a life-cycle fund geared to a targeted retirement date or a professionally managed portfolio of funds based on the participant's age, gender, marital status, risk tolerance and years until retirement. In some plans, contribution levels rise automatically each year to reflect pay increases. If there's a company match, those automatic increases can help employees capture more of it. Employees always have the right to adjust the contribution amount and the investments if they don't like the default choices.

"Employees who are pressed for time, or who lack confidence in their ability to develop the right asset allocation, are increasingly gravitating toward automatic retirement services that take much of the guesswork out of investing for retirement," Carey says. As their balances grow, it can encourage workers to save even more.

In an analysis of retirement plans representing nearly 11 million workers, Fidelity found that more than 1,200 plans added life-cycle funds in 2004. The second-most-popular addition was an automatic increase in annual contributions.

William Gale, co-director of the Urban-Brookings Tax Policy Center and co-author of a paper on the autopilot concept, calls it "the most promising approach to bolstering retirement security for millions of American families." He says the goal is to "design a 401(k) to recognize the power of inertia in human behavior and harness that power to promote, rather than hinder, saving."

Helping hands

WHEN GENESIS HealthCare Corp., in Kennett Square, Pa., began offering a managed-account option last year, Cheryl Parson, 54, was quick to sign up. After 18 years of contributing to the company's 401(k), she was thrilled to have a professional take over the investment decisions. She enrolled online in the Wachovia Advice Track program and answered some questions about her age, retirement goals and risk tolerance. Wachovia advisers recommended a more diverse portfolio than she had chosen on her own. Her investments are reviewed quarterly and rebalanced as necessary.

The program includes 12 mutual funds, and the managed-account service costs 1.2% to 1.3% of assets each year. (If you have $10,000 in an account, a 1.2% fee equals $120 a year.) Parson considers it money well spent and believes it buys better performance than she could achieve on her own, not to mention peace of mind.

Although single-fund investment options, such as life-cycle or lifestyle funds, are increasingly popular, the Advice Track program offers something they don't. "The lifestyle fund doesn't tell you if you are on target to meet your retirement-income needs," says Keith Sykes, defined-contribution product manager with Wachovia Retirement Services. "We give them an annual checkup that shows them where they are, where they need to be and how they can close the gap."

Wachovia was one of the first to offer managed accounts for 401(k)s, and other major players have jumped on the bandwagon. Fidelity introduced its Retirement Plan Manager program in 2003, and Morningstar Associates rolled out its Retirement Manager program in 2004. Financial Engines introduced managed accounts to more than 160,000 workers at J.C. Penney and Motorola last year.

"To reach these reluctant investors-who typically represent 40% to 50% of a plan's members-we have tried to make it as easy as possible and then let inertia take over," says Christopher Jones, vice-president of investment management for Financial Engines. "I expect most plan participants will have access to these kinds of services over the next couple of years." If your plan does not offer them now, you may want to ask your 401(k) administrator to check into them-for your sake and the sake of all your fellow employees.

Sign me up

A RETIREMENT coordinator for Genesis HealthCare, Parson says she has heard nothing but rave reviews from employees who have signed up for the managed-account option. Before it was offered, fewer than half of the 20,000-plus employees who work in the company's nursing homes and assisted-living and critical-care facilities participated in the 401(k) program. Since Advice Track arrived last August, enrollment has jumped by more than 10%, and three-fourths of those who signed up are having their contributions increased automatically by 1 % a year.

According to the 2005 Retirement Confidence Survey published by the Employee Benefit Research Institute (EBRI), 62% of workers say they are currently saving for retirement. Of those who aren't, two-thirds say they would be more likely to save if they had a lifecycle fund as an investment option. More than one-third of nonparticipants said they would be more likely to join a plan if a pro made investment decisions.

The biggest single incentive that workers say would entice them to participate in a 401(k) plan is a substantial matching contribution from their employer. Nearly three-fourths of workers who steer clear of their 401(k) say a matching contribution of up to 5% of their salary would make them more likely to save for retirement, according to EBRI's survey.

Amy Sadaune, a vice-president of human resources for First Community Credit Union, in Houston, already defers 10% of her salary to her 401(k). That's almost double the average deferral rate for most retirement-plan participants around the country. Sadaune, 37, wants to capture every dime of her company's generous matching contribution. First Community Credit Union matches employee contributions dollar for dollar up to the first 10% of salary. (That's well above the typical match of 50 cents on the dollar for the first 6% of salary, for a total average matching contribution of 3%.)

Sadaune and her husband, Gery, who also maxes out his 401(k) contribution at work, are planning for an early and comfortable retirement filled with international travel. With no children or college savings to worry about, Amy and Gery, 35, hope to retire in 20 years. Amy proudly says they're on track to replace more than 100% of their current income in retirement.

She plans to boost her 401(k) contributions by 1 % a year for the foreseeable future, or until she hits the legal maximum. (That's $14,000 this year for those under age 50, but it will increase in the future.) She signed up with her company's new Step Ahead program to put those 1% hikes on autopilot. "This will let me boost my 401(k) contributions automatically," she says, "so I won't have to think about it."

Some automatic 401(k) plans raise contribution levels each year to reflect pay increases.

401(k) CHECKLIST

If your employer doesn't offer an automatic 401 (k) plan, here are some simple rules to put you on the right track to a secure future.

Contribute as much as you can, and at least enough to capture your employer match, if there is one.You can contribute up to $ 14,000 this year, or $ 18,000 if you'll be 50 by year-end. (Employers' contributions don't count against the limit.)

Consider contributing to a Roth IRA first if your company doesn't offer matching 401 (k) contributions. There's no tax deduction for a Roth, but withdrawals are tax-free in retirement. After you stash $4,000 a year in an IRA, jump into the 401 (k).

Review asset allocation. Are you investing aggressively enough if you are young, or moving into a more conservative mix if you are near retirement? About half of all plan sponsors offer investment advice by phone, in person or online.

Rebalance your account. If uneven performance of various investments has caused your asset allocation to stray, bring your account back into line. It will force you to sell your winners and reinvest the profits.

Select one fund. If words such as asset allocation and rebalancing make your head spin, choose a life-cycle fund based on your retirement date.

Put your plan on autopilot. If your plan offers this option, sign up to increase your contribution automatically each year to keep long-term savings on track and reduce your current taxable income.