401(k)

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It’s called the Automatic 401k re-enrollment. The WSJ reports:

In a bid to help employees get their retirement savings on track, more 401(k)-plan sponsors are shifting workers’ 401(k) dollars out of their current investment allocations and into the plan’s default option—usually a target-date fund.

It’s called re-enrolling. Employees have the options of sticking with their current investment selection, if it’s still offered, or choosing another mix. But in a re-enrollment, unless the participant specifically opts out, his or her 401(k) will be re-allocated to the company’s chosen default investment.

As with automatic enrollment, opt-out rates are low.

Mr. Reish and his colleagues, who represent several major 401(k) providers, were initially worried about potential push-back from employees. However, only one worker complained, saying a target-date fund would be too conservative, he says. Others opted out with no gripes about the process.

All told, about half of the employees re-elected their prior investment selection or selected some other investment strategy.

Employees who opt out are more likely to be better educated, older and more affluent than those who accept the default, says Mr. Utkus.

Reish & Reicher’s opt-out rate was higher than most companies that undergo a re-enrollment.

Indeed, for companies moving their 401(k) plans to T. Rowe Price Group, the acceptance rate is much higher and has increased in recent years, says Carol Waddell, director of product development for the company’s retirement-plan-services unit. Among employers that shifted their 401(k) plans to T. Rowe Price and conducted a plan “reset,” roughly 87% of all participants remain in the target-date fund 18 months after the conversion, she says. Ms. Waddell adds that 57% of plans transferred to T. Rowe Price in 2009 conducted plan resets for their employees, compared with 14% in 2005.

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Faced with restaurant manager churn, McDonald’s decided to offer a generous company match to its 401k plans. Automatic enrollment with a 1 percent automatic annual deferral of salary were the default rules. To “ease the pain” of the 1 percent deferral, the company gave managers a one time 1 percent bump in salary. Hat tip: Kare Anderson.

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…for workers over age 22 in a new supplementary State retirement plan, if they aren’t participating in a better plan at their work. We’ll come back to what’s “better” in a minute. The choice architecture of the Irish plan is stronger than the plans used here in the U.S. and therefore bound to be more controversial. People who sign up get bonus payments from the government if they stay in for five years, and if someone opts-out, they are automatically re-enrolled again every two years. In other words, you have to keep opting out of the plan.

Over at the Geary Behavioural Economics Blog, Liam Delaney offers some excellent observations about the whole reform plan, which goes beyond automatic enrollment. Compared to the U.S., the plan is a generous one. One of its features is a 4 percent matching contribution that is split between an employer and the government. If a worker is in a plan that matches at higher levels–and therefore is “better”–that worker is not placed automatically in the State plan. But what if an employer’s “worse” plan currently matches at lower levels? asks Delaney.

The employer contributions aspects create strange incentives for employers. For example, a company with 100 workers earning 20-40k per year that currently has a pension scheme with 30 per cent take-up, could find themselves with an extra fifty thousand or so per year to pay in terms of staff costs. While the employer would be obliged under the current scheme to enroll people onto the pension plan, they would not be obliged to enthusiastically endorse this to their workers. The social interactions that take place in this regard are interesting to think about. In general, the employer response to a national automatic enrollment scheme where the employers are bearing a good chunk of the costs is an element not usually present in the US literature.

Addendum: Conversation about the new pension system here.

Addendum Too: 12 skeptical questions about the plan from Constantin Gurdgiev.

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Three senators have proposed a law that would require employers to tell their 401(k) participants how much money they are projected to earn each month based on the current balance of their account. Since most Americans don’t have much money in their 401(k) accounts, the disclosure would quickly highlight how much more they need to save. For instance, the average 401(k) account produces just $225 a month in income. From there, one of two things could happen.

Best case, they increase the amount they contribute to their 401(k), which presently averages 7%. Or, worst case, they increase the amount they invest in stocks, thus increasing their exposure to market risk. At the moment, the evidence seems to suggest that many workers don’t have a clue about how to invest the money in their 401(k)s.

For older workers who need their retirement nest eggs soon, the worst case scenario is potentially devastating. Full story at Marketwatch.

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Automatic enrollment has gained a following. What about one-click IRA/401(k) consolidation?

The scattered-accounts problem is actually a risk with the auto-I.R.A., too. Its architects envision a strict limit on the number of investment choices. That makes it different from normal I.R.A.’s, where you can often invest in whatever you’d like. Even if all auto-I.R.A.’s offered the same limited menu, no matter which bank or brokerage was administering it, account owners could still end up with a bunch of different I.R.A.’s years from now.

Mark Iwry, nonresident senior fellow at the Brookings Institution, said that he and David John, a senior fellow at the Heritage Foundation, who together came up with the auto-I.R.A. idea, were well aware of this potential problem. “Our direction is to facilitate the potential consolidation,” Mr. Iwry said…“You’re told that you have two I.R.A.’s, here’s where they are, and if you want to combine them you could just click here.”

If that sounds a bit messy, well, that’s the paradox of simplification. “Simplifying is a lot of work. It’s a complex undertaking,” said Pamela F. Olson, a partner at Skadden Arps in Washington, who was assistant secretary for tax policy at the Treasury Department during George W. Bush’s first term as president…In fact, it’s hard to get people riled up about the topic in the first place.

Or as another tax lawyer in the story notes, “There’s no real constituency for simplification.” Actually, there is a constituency. It’s just large and diffuse, and therefore, unlikely to organize.

Hat tip: Amelia Kaye

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On page 37:

Making Saving for Retirement Easier as the Economy Recovers.

Over the long-term families need personal savings, in addition to Social Security, to prepare for retirement and to fall back on during tough economic times like these. However, 75 million working Americans—roughly half the workforce—currently lack access to employer-based retirement plans. In addition, the existing incentives to save for retirement are weak or non-existent for the majority of middle and low-income households. The President’s 2010 Budget lays the groundwork for the future establishment of a system of automatic workplace pensions, on top of and clearly outside Social Security, that is expected to dramatically increase both the number of Americans who save for retirement and the overall amount of personal savings for individuals. Research has shown that the key to saving is to make it automatic and simple. Under this proposal, employees will be automatically enrolled in workplace pension plans—and will be allowed to opt out if they choose. Employers who do not currently offer a retirement plan will be required to enroll their employees in a direct-deposit IRA account that is compatible with existing direct-deposit payroll systems. The result will be that workers will be automatically enrolled in some form of savings vehicle when they go to work—making it easy for them to save while also allowing them to opt out if their family or individual circumstances make it particularly difficult or unwise to save. Experts estimate that this program will dramatically increase the savings participation rate for low and middle-income workers to around 80 percent.

The idea draws praise from bloggers at both Heritage and the Nation. The trend of companies offering automatic enrollment is slowing. Strangely, more than half of them say they aren’t adding automatic enrollment because of the increased costs of an employer match. Strange, since the two can be uncoupled easily.

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Pension fund talk really gets the blood flowing, doesn’t it? Well, we’re going to try our wonky best.

India’s Pension Fund Regulatory and Development Authority (PFRDA) is the government body responsible for regulating the country’s pension sector. In response to a proposal for new pension system that features defined contribution plans and professional financial funds, the PFRDA recently published a report on recommendations for this new plan. (The paper is no longer online, so special thanks to Amol Agrawal for sending it our way. We’ll post it if it comes back online.)

The paper’s discussion of the default rule is an interesting window into how thinking about default rules for investments has changed over the past decade, and how policymakers in different countries may end up addressing this issue.

Continue reading the post here.

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From former CBO director and soon to be Office of Management and Budget director Peter Orszag.

The overall share of 401(k) participants with 90 percent or more of their assets invested in company stock is more like .47*7.3=3.4 percent. It’s still too high…The good news is that the trend is towards less investment in company stock. For example, in 1999 EBRI estimated that 19.1 percent of all 401(k) assets were held in company stock…By 2006, that share had fallen to 11.1 percent.

The figure below, which shows this decline, comes from the Employee Benefit Research Institute. The company stock figures are the second batch of bars from the left.

company-stock-401k-chart

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Large companies are doing better than small ones. And more than 10 percent of the total rise has come since the passage of the Pension Protection Act. See the below side from recent presentation by CBO director Peter Orszag.

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The Pension Protection Act of 2006 gave companies some carrots for adopting auto-enrollment 401(k) plans, a favorite nudge of ours. A paper out earlier this summer by the Employee Benefit Research Institute draws some preliminary conclusions about its effect – chiefly that there is a “very significant positive impact in generating additional retirement savings for many workers, especially for low-income workers.” (Go here for the full summary)

For example, under one set of assumptions used in the Issue Brief, the median 401(k) accumulations for the lowest-income quartile of workers currently age 25–29 (assuming all 401(k) plans were voluntary enrollment) would only be 0.1 times final earnings at age 65 (this is largely due to the fact that 41 percent of workers—as opposed to participants—were assumed to have zero balances at age 65). However, if all 401(k) plans are assumed to be using the safe harbor automatic enrollment provisions under PPA, the median 401(k) accumulations for the lowest-income quartile jumps to 2.5 times final earnings under the most conservative assumptions and 4.5 times final earnings under the set of assumptions most beneficial to participants.

Even among higher paid workers the increases are considerable. The multiple jumps from 1.8 times final earnings under a voluntary enrollment scenario to between 6.5 to 10.4 times final earnings under an automatic enrollment scenario, depending on one’s assumptions about automatic escalation of contributions.

While individual company adoption of auto-enrollment is good for that company’s workers, a bigger lesson of the paper is the need for universal adoption. In an age when workers switch jobs more frequently than ever, the risks to saving among many, especially those predisposed not to enroll, are large. Based on projections by the authors (with some assumptions for average savings rates and salaries), individuals who are automatically enrolled in a 401k at their work and remain there for life end up with median replacement rates at retirement ranging from 51–69 percent. The replacement rate is the percentage of a worker’s final salary that is replaced in retirement by a nominal annuity purchased with 401(k) assets. If a worker switches jobs, however, and only has an average chance of being automatically enrolled, the replacement rate range drops to 21-26 percent. That’s serious money.

Hat tip: Mostly Economics

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