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Rethinking 401k auto-enrollment

Rethinking 401k auto-enrollment

| May 26, 2024

I enjoyed reading 401k expert Prof. Shlomo Benartzi's post on rethinking 401k auto-enrollment to address societal gaps. Ah, but to have been a fly on the wall at his recent 401k geek dinner. From the dinner attendees came several ideas on how to rethink or reimagine 401k auto-enrollment. Here are my thoughts and ponderings on the topic based on 34 years in the industry.

The first proposal was to offer auto-enrollment without opt-outs. In the current 401k system, an employee is auto-enrolled into the plan at the proper eligibility time but the employee has the right to opt-out of the 401k. While the proposal suggested that an employee who does not enroll now must commit to enrolling next year or the year after, I offer a different tack.

Part of the concern I have with deferring now is that an employee may lose out on the employer match. How much you might accumulate for retirement is primarily based on how much you save and how early you start. Allowing employees to defer can decrease the amount they will have at retirement both from missed contributions and match.

The discussion also touched on the fact that the typical American worker switches jobs 9 times throughout their working years. Does the deferral auto-enrollment clock reset each time an employee joins a new company? That seems likely. And those subsequent deferrals can further reduce a potential retirement nest egg.

An additional thought I had on proposal #1 is how to handle employees who have multiple jobs and those who are not being paid a living wage. One of my 401k clients is a restaurant. Some of the waitstaff have other jobs and the restaurant "gig" is a third job for spending money. They might not want to enroll in the 401k as they are covered by another company plan.

As to the living wage issue, there was a time in my career where I did not have two dimes to rub together. Addressing the living wage issue first might make the deferment issue moot and academic.

The second proposal in the auto-enrollment discussion is one of portable contribution rates. Each time an employee switches jobs, their contribution rate would carry over to the next job as opposed to going back to the low auto-enrollment rate (i.e., 3%). This certainly makes sense to me as when I switched companies, it was for higher pay. But I have encountered my share of employees who are at a new company and earning far less than before for a variety of reasons. The second proposal notes that AI could help suggest a savings rate for those who took a pay cut. Employees can change the contribution rate as appropriate. I like this proposal as I have not had a current employee or retiree say to me, "Timothy, I have too much money".

The third proposal was for a progressive match formula wherein the match could be higher for lower paid employees and lower for the higher-paid. I like this bit of social engineering! And while my mind immediately ran to the annual ACP test, my out-of-the-box side dismissed it with a casual, "Testing rules can be rewritten".

I would even go a step further and look a mandatory true-up. I was chatting with an employee who was hired mid-year and started 401k contributions immediately. She was concerned that she would not get the full match of her annual salary because the match is paid per paycheck. Her match formula of $1:1 up to 4% on her salary of $65,000 would result in an annual maximum match of $2,600. Even though she was hired mid-year, she was aggressively contributing such that her six months of contributions would easily hit $2,600. But, because she was hired mid-year, her match for the first year was only $1,300. Perhaps a mandatory true-up would help?

It is easy for me to make these proposals. I am not the CEO/ CFO looking at cashflow. And yet, it makes sense to me for society to pay a bit more now than to pay a lot later on. I am not discounting the need for personal responsibility.

But an employee who is retiring without a proper sum of money can find themselves having to avail of government services more frequently. Wouldn't it be better for all concerned if they could stand on their own two feet? Isn't one part of the American Dream for all to be able to retire with dignity? Shouldn't we do everything we can to try to facilitate that?

I can't wait to read Part 2 of the proposals that came out of this 401k geek dinner.