Default 401(k) enrollment weighed to lift savings rate

Author: Timothy Spence

Published: March 20, 2005

Although President Bush's proposal of Social Security private accounts has galvanized opposition from Democrats and politically powerful retiree organizations, all sides agree on one thing: Americans need to save more for retirement.

Bush and some Republicans in Congress say Social Security investment accounts will increase savings. But others counter that retirement income can be boosted without altering Social Security. One such proposal on the table is making enrollment in workplace 401(k) plans automatic.

"You can like privatization or not and still see the advantages of automatic enrollment," says William G. Gale, an economist and the co-author of a new report on self-directed retirement plans.

The report by the Retirement Security Project, a group that seeks to improve savings among low- and middle-income families, describes the automatic 401(k) as a "disarmingly simple concept" to improve the retirement security of millions of workers.

More than 70 percent of public- and private-sector workers who have the option of enrolling in 401(k) plans actually do so. Nearly all of these plans require the employee to take the initiative, filling out enrollment forms and making their investment selections.

But there is a glaring disparity in participation among younger and low-wage workers - some of the very people that Bush says would benefit over the long haul from Social Security investment accounts.

Researchers at the University of Pennsylvania's Wharton School estimate that only 13 percent of new workers earning less than $20,000 sign up for such savings plans. Gale argues that if these workers were automatically enrolled when they are hired, it would help them build better retirement nest eggs.

Waiting, Gale says, means that such workers lose out on the benefits of compound investments.

Democrats and Republicans are using the emerging Social Security debate to urge people to take more responsibility for their personal savings as the first wave of baby boomers born in the two decades after World War II begin to retire.

"Everybody says that Social Security isn't supposed to be the only retirement," says Rep. Bill Thomas, R-Calif., the chairman of the House Ways and Means Committee who is receptive to the Bush private-account proposal. "We have to look for ways for people to save for their retirement."

The Retirement Security Project is not alone in calling for an expansion of 401(k) coverage. William D. Novelli, chief executive of AARP and a leading critic of Bush's Social Security plan, said in a recent speech in Washington that if new employees of companies with retirement savings plans were "automatically enrolled and had to make a conscious decision to opt out, savings would increase dramatically."

Economists refer to Social Security, pensions and personal savings as the "three-legged stool" of retirement income.

Baby-boom retirement will strain Social Security. And the 401(k) has largely replaced traditional pension plans for most private-sector workers. The authors of the Retirement Security Project study say their concept is not an alternative to Bush's Social Security proposal, but only intended to boost involvement in workplace retirement plans.

In 1981, more than 60 percent of workers had a traditional pension plan, while today a similar percentage of workers have only the option of a 401(k).

These programs are popular with employers because they are less expensive to manage than traditional defined-benefit plans, for which they corporations bear nearly all the cost. They allow the employee to decide where their money will be invested - whether in stock or bond mutual funds, or in fixed-income accounts. They also are popular with employees because investing is relatively hassle-free, and contributions lower workers' taxable income.

In addition to automatic enrollment, Gale and two colleagues at the Retirement Security Project - J. Mark Iwry, a former chief pension regulator for the U.S. Treasury, and Peter R. Orszag, a noted expert on Social Security at the Brookings Institution - say Congress should consider these changes to encourage greater participation in workplace retirement accounts:

Enact a law to give companies that automatically enroll workers protection form legal liability if the default investment account is invested in a diversified or stable mutual fund.

Ensure that state laws do not create regulatory obstacles to automatic enrollment.

Protect employers from financial loss, such as fees or investment expenses, if an employee demands sudden withdrawal from the 401(k).

The U.S. Treasury and Internal Revenue Service approved the automatic option on workplace retirement accounts in 1998. Still, only about 8 percent of 401(k) plans provide default enrollment.

While there is broad agreement that workers need to save more for retirement and should tap into options available to them - including individual retirement accounts, or IRAs, and workplace plans - 30 years of tinkering by Congress to boost savings has created a complex set of options with varying tax advantages.

"It's a very complicated web that we've created and fixing it won't be easy," said Lee Price, research director for the not-for-profit Economic Policy Institute in Washington and chief economist at the U.S. Department of Commerce from 1996 to 2000. Still, he agrees that automatic 401(k) enrollment "is a good idea" in giving lower-income workers some retirement security.