More Companies Make Employees Opt Out of 401(k)

Two years ago, Olivia Farrell, CEO of Arkansas Business Publishing Group, presided over a mandatory staff meeting wearing a black satin cape and carrying a top hat.

Out of the hat, she pulled $10 bills and handed them randomly to staffers while she made her point: The company gives “free money” to employees who participate in the 401(k) plan. By the end of Farrell’s magic show, during which she explained that her own retirement savings was limited by employee participation, she had given a 10-spot to almost every one of her 60 employees.

The result of her dramatic sales pitch for long-term financial planning?

“I think we had one more participant sign up,” she said. About 65 percent of ABPG’s employees participate in the plan, a figure that is below the national average and has barely budged despite increasingly generous employer matching of their contributions.

Farrell’s frustration is not unusual, especially in companies with a fairly large concentration of younger workers.

“I don’t think people realize that their retirement is on their own shoulders through their 401(k)s,” said Mimi Hurst, a chartered financial analyst and vice president in the Stephens Capital Management division of Stephens Inc. in Little Rock. “It does take a significant amount of education and continual enrollment meetings to increase your participation from whatever it is.”

It may also take a big change of approach. Over the past two years, more employers have adopted policies that automatically enroll new employees in 401(k) plans and have increased the default rate of contribution to their accounts, a national survey by human resources outsourcer Hewitt Associates of Lincolnshire, Ill., found.

A third (34 percent) of the more than 300 mid-sized and large companies Hewitt Associates surveyed this year had adopted automatic enrollment policies – sometimes called “opt out” or “negative election” policies – compared with 19 percent in a similar survey in 2005.

“It’s the only way to get dramatic results,” Pamela Hess, Hewitt’s director of retirement research, said.

“The average participation rate has hovered around the low 70s. Automatic enrollment had been able to move that pretty dramatically, often to the 80s and 90s.”

New federal law and regulation should increase the popularity of automatic enrollment in retirement plans and more aggressive “default” investments for employees who fail to direct their own investments.

Beginning Jan. 1, the Pension Protection Act signed by President Bush in August 2006 offers legal protection for companies that enroll employees in 401(k) plans without their consent, as long as the employees are allowed to “opt out” of participation. And in October, the U.S. Department of Labor issued final regulations giving companies legal cover for losses if they make a good-faith effort to invest employee contributions appropriately. In typical bureaucratic fashion, this is referred to as QDIA – qualified default investment alternatives.

Hewitt Associates found that the companies that automatically enrolled employees, unless they specifically opted out, were already becoming braver in the way they handled those employees’ accounts.

If the employee didn’t self-direct the investment, more than three-quarters of the companies “defaulted” to a diversified portfolio. (According to Hurst, the default investment generally used to be cash, which never lost value but didn’t grow appreciably, either.)

And the share that set their default rate of employee contribution at more than 3 percent had risen from 66 percent in 2005 to 83 percent this year.

 

The Right Start

Automatic enrollment is appealing to employers because they know too many employees aren’t saving for retirement or aren’t saving enough. Of the approximately 75 percent of employees who participate in 401(k) plans, the average annual contribution is 7.9 percent of salary, Hess said.

“It’s frustrating,” she said. “Employers want to do the right thing; they want to get their employees to participate. … They see this problem, and how do you fix it? If it’s not automatic enrollment, how do you get there?”

Automatic enrollment has the advantage of “nudging people forcefully into these plans,” said Kelli Kolsrud, senior information specialist for the International Foundation of Employee Benefit Plans in Brookfield, Wis.

“I certainly think that it’s something that is growing because, as the years go by, there are fewer traditional pension plans, which are the defined benefits plans, and more focus on the defined contribution plans. And that certainly puts the onus on the employee.

“And what [employers] were finding is that employees were not doing this as much as was recommended.”

The new Department of Labor regulations on qualified default investment alternatives, Hess said, “provide a safe harbor for employers” if they default employee contributions into an investment strategy that ends up losing money.

And the most popular investment funds – which Hess enthusiastically endorsed – are “target maturity funds” that automatically adjust the investment mix as the employee gets closer to a target retirement date.

“For the people who do get in [to the 401(k) plan], it’s so important for them to do the right thing from day one because you know they won’t come back and revisit it,” she said.

Hewitt’s research found that fewer than 20 percent of participating employees make any change in their investment strategy during any given year. That, Hess said, is why target maturity funds have “caught on like wildfire,” and not only as default options for automatic enrollment but for engaged 401(k) participants as well.

“The target maturity funds are one of the best ways. They become more conservative as the employee gets older and closer to retirement,” she said.

And automatically increasing the amount of the employee’s contribution is also growing in popularity. More than a quarter of the companies Hewitt surveyed had also adopted automatic contribution escalation, often with target rates of between 8 and 15 percent, Hewitt’s survey found.

 

Best Practices

While automatic enrollment is the single most effective way to increase participation in 401(k) plans, there are other things that can help.

• Earlier eligibility. The International Foundation of Employee Benefit Plans of Brookfield, Wis., in a survey conducted with Deloitte & Touche accounting firm, found that 49 percent of employers surveyed in 2005 allowed new employees to participate in the retirement plan immediately.

Only 12 percent required employees to wait a full year before being eligible.

• Mandatory enrollment meetings. “When employees have mandatory meetings … then it becomes a little bit more of an incentive to fill out this paperwork quickly,” Hurst of Stephens Capital Management said. And Hess agreed: “If you make people do something on the spot, you get more action. … Give them a deadline. A lot of people really do want to do the right thing, but they just don’t get around to it.”
• Matching contributions. “Having a match is really an important step,” Hess said. “You are getting some reward for doing it. That is really important in participation rates, but we still feel that people who are going to save are going to save.”

What’s more, a 2006 study by Hewitt found that almost 22 percent of participants didn’t contribute enough to get the full company match, and another 30 percent contributed just enough to get the maximum match. “There’s a lot of money being left out there that folks are missing out on and are going to need someday,” Hess said.

• Frequent communication through multiple channels. “Even more effective [than upping the employer match] in increasing participation is communication. Not only strong communication but frequent communication,” advised Kolsrud, of the International Foundation of Employee Benefit Plans. She also suggested conveniently timed one-on-one meetings that can even include a spouse. “We are dealing with adults here, and you can only do so much as far as forcing them into this behavior, but it maybe takes more than just once-a-year communication,” she said.

“You need a lot of different arrows in your quiver to reach a lot of employees,” Hess said. She recommended personalized communications, either by letter or e-mail. And educational outreach should recognize differences between genders and races. African-Americans have a significantly lower participation rate than white Americans, Hess said, and women tend to invest much more conservatively than men.

Newsletters are popular – the IFEBP found that 71 percent of employers use them. But for increasing 401(k) participation, Hess said, they are “modestly successful, but they tend to appeal to people who are interested in the topic.”

• Simplified paperwork. Hess suggested a letter telling an employee how much matching money he’s missing out on accompanied by a detachable card to send back in order to enroll in a default investment strategy.

“More and more plans are trying to streamline and make things much simpler,” Hess said, in contrast with the 1990s, when there was a rush to add more and more investment options that often confused employees.