Money To Live

February 8, 2010

Default Enrollment in retirement accounts

Filed under: Uncategorized — by moneytolive @ 1:17 am

A relative recently asked me about a 401(k). She is automatically enrolled at a 4% employee contribution. To cancel the contribution, she would have to set up an online account and change settings in her account, which I suspect would take less than 20 minutes.

For many people without a plan for retirement savings, the default option from an employer is a great way to start saving.

What is default enrollment?
Behavioral economics research shows that people are lazy and usually stick with the default option – on retirement accounts, organ donation, or just about anything. For retirement accounts, the idea is that if the default is to enroll, most people will not go to the bother of changing their account, and some retirement savings are better than no retirement savings. This type of enrollment is frequently called “opt-out” because you have to opt-out, not opt-in, as for many historical plans.

There are different flavors to the opt-out:
* Default enrollment at a fixed contribution amount (say 4%)
* Default enrollment in a regular increase (if you start at a 4%
contribution, next year it will bump up to 5%, the next year 6%, and
so on).
* Sometimes opting out is not an option. I was recently a victim of one of these retirement systems. It took 4 phone calls and three emails to figure things out — and every single person I talked to gave me a different piece of wrong information. No chance to opt out = I am subsidizing the State of Ohio pension fund.

What about an Employer Match?
If you get an employer match, fund at least up to the amount to capture the employer match. Do this even if you’re not sure you will be employed long enough for the amount to fully vest. Worst case is you get no vested amount. Maybe you’ll stick around longer than you thought, and maybe you’ll leave with a partial vestment.

Why you should contribute even without an employer match (maybe)
If you are maxing out your other retirement options (i.e., IRA), a 401(k) gives another avenue for tax-advantaged retirement savings.


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