Tuesday, April 24, 2007

Opt-Out 401k Plans - a Good Idea?

Regular readers of Money and Such know about my company's search for a new 401k provider. Well, the search continues, and the dilemma-du-jour is whether we should adopt provisions for automatic enrollment of new employees into the program.

There appears to be a philosophical disagreement between me and one of the other members of the 401k management team. Although I am very much against protecting people from the consequences of their own choices, I do believe that there are some exceptions to this rule, and retirement planning is one of those exceptions. Left to their own devices a certain percentage of the population would completely disregard the need to save for retirement, until it is too late. Some would rather spend the money now, others are simply too lazy or procrastinate for years before enrolling in their employer's retirement plan. Whatever their reason, because they fail to save some employees will not have enough for retirement.

Employers have certain moral obligations towards their work force. Ensuring that their employees are well prepared for retirement is one such crucial responsibility (on par with providing medical coverage). Since companies have all but eliminated traditional pension plans, they have a moral obligation to ensure that their employees are saving enough for their own retirement. As such, I am very much in favor of an automatic enrollment provision in our new 401k plan.

My colleague objects. He is firmly on the side of personal choice and responsibility. From his perspective, adults have the right and responsibility to care for their own needs. He feels that the employer's burden ends when it offers employees the option to invest in a 401k plan. He concedes that adequate training and education to the employees is also a major responsibility of the company. My colleague believes that by adopting automatic enrollment, we would be infringing upon employees freedom of choice in a way that could negatively impact their financial situation. He also worries that by adopting opt-out enrollment we could be opening ourselves up to law suits by disgruntled employees.

I agree with some of my colleague's arguments, however I think that an easily available and well communicated opt-out option allows those that do not want to participate in the plan to simply walk away, while offering the procrastinators a pain-free way of saving for retirement.

It appears that we have a philosophical disagreement on our hands. I believe that in the end my point of view will be accepted, but I will keep you posted on the developments.

One more interesting question: if we do indeed adopt an opt-out provision, where should the money be invested? I am leaning towards a target fund which invests employee contributions in a mixture of stocks and bonds. The mixture would change based upon each employee's age. The alternative, money market funds, is not appealing because returns may not even keep up with inflation and so we would be doing a disservice to our team members. Of course, target funds carry a certain level of investment risk and I am conflicted about whether we are justified in assuming that level of risk on behalf of employees. I think that the answer is probably "yes", but I am not yet convinced.

For additional reading on the subject, take a look at this interesting USA Today article.

If you have any advice or suggestions, please leave a comment. Would you want an opt-out provision in your 401k plan? Do you have one?


plonkee said...

I agree with you on the opt-out rather than opt in. You could be making a big difference to some people's lives in retirement.

We have something similar at work and our default choice is a lifestyled fund - its invested in 2 trackers (one domestic, one global) and then as you get closer to retirement age a percentage is invested in bonds.

silverbax said...

If you automatically enroll a new employee, are you automatically allocating their contribution percentage? I'd be completely against that. On a related note, I think companies should not only offer 401k but also set up their payroll to allow employees to deposit money into their own existing accounts before taxes as well as HSAs. Right now every employer I've worked for doesn't ddo that, and only offer the less attrractive FSAs.

frugal zeitgeist said...

I agree with you as well. My employer is moving to an opt-out program and I think it's very much to employees' overall benefit. I've heard some absolute horror stories from fellow employees that convinced me that some people need to be protected from themselves in some areas.

Tom said...

I would say that an opt-out plan with default contributions going to the target fund closest to the employee's projected retirement date would be the way to go.

For example, if I did not opt out, my funds would automatically go to, say, FFTHX, assuming Fidelity was doing the 401k.

Karla (ThreadBndr) said...

If you are doing the opt-out, what % is the automatic enrollment? The company match point? Some lesser amount?

BTW, I'll be going to the company sponsored retirement seminar later this month. We may be getting the chance at a Roth401(k)! Watching your struggles with this subject has given me lots of questions to ask.

My Boaz's Ruth said...

um. and if someone is getting a job expecting to need every cent? I think you might well be opening yourself up to disgruntled employees if you take their money and invest it somewhere they can not get it back when they are expecting to have that money on hand to live on.

and that is even knowing that is what they SHOULD Do -- but there are times in my husband and my's short history that we needed every dollar of my pay (or his) to live on and this would be a rude shock to discover at the time of the first paycheck.

Shadox said...

Thanks everyone for some really insightful comments.

To some of your questions:

1. We are considering an opt-out 401k plan. If we adopt this strategy we will CLEARLY and REPEATEDLY communicate to employees that all they need to do to remove themselves from the plan is to sign a letter at the time they accept the job offer. We will not wait until they receive the pay-check to find out that they are contributing to a 401k.

2. I am leaning towards a target retirement date fund as the default place for investing the money.

3. The default contribution limit should be low - probably around 3%, even though that is below the company match limit and far less than most people would need. The objective is to give people a nudge in the right direction not to make major decisions for them, and most people can afford a 3% reduction in pay (probably around 2% after taxes).

4. Some of the comments people posted show the sensitivity of this issue and the reason we are deliberating the topic. It is a hard decision to make, either way.

PF101 said...

I had a long post done but blogger keeps eating it so I'll leave it at this:

I'm a big supporter of the opt-out system and I think 3% into a target fund is the way to go.

Good luck!

Jim Bigham said...

FYI: The auto-enrollment scheme has two beneficiaries. Management (HCE's to be specific), who's contributions are limited if the rank & file fail to contribute AND the Vendors, virtually all of whom are paid based on Asset value. These auto enrollment features will add billions in assets to their plans (or funds or annuity or omnibus account) and millions of dollars in profits.

Seriously though and this is in no way a knock on management; If they could contribute 100% of the amount allowed by law, and not have that amount REDUCED due to participation, this would be a moot issue. Not even on the radar screen.


Jim Bigham
The 401K Insider Blog