Employers Make 401(k) Enrollment Automatic/Broad Changes Are Suggested for Retirement Savings Plans

Over 60 million Americans were enrolled in 401(k) savings plans at the workplace as of 2023 according to The Investment Company Institute (ICI). Total 401(k) assets reached an estimated $6.3 trillion, down from $7.2 trillion in mid-2023.

Employers have been changing their tactics in order to encourage more workers to participate in savings plans. The biggest change is that the largest companies now tend to enroll their employees in savings plans automatically, rather than waiting for the employees to request enrollment on their own. (Employees may opt-out but must do so in writing.) This greatly boosts participation, particularly among workers of modest income. Next, employers are providing workers with greater investment plan choices and much better opportunities for education about investing in their plans. Some employers are making it more difficult for employees to make pre-retirement withdrawals from their plans except in cases of extreme hardship. The employer-sponsored savings plan has been a major contributor to the growth in stock investment participation in the U.S.

Dominant players among 401(k) fund providers include Fidelity and Vanguard. Other financial firms, including Bank of America, JPMorgan Chase and Wells Fargo, have substantial 401(k) operations. The increased competition may bring about lower fees and an increase in program choices for employers.

“Target-date” mutual funds are growing in popularity for use in 401(k)s, despite the fact that they may endure relatively high management fees. A target-date fund is so-named because it continually adjusts investment strategy from higher-risk during a worker’s younger years to lower-risk near a targeted retirement date as the worker ages.

401(k)s were first established on January 1, 1980, as a way for people to save for retirement on a tax-deferred basis. (Johnson & Johnson, PepsiCo, Honeywell, Hughes Aircraft and JC Penney were among the first employers to offer the plans.) Eligible workers make contributions to these accounts, and many employers match some portion of employee deposits as a benefit. The system works very well as long as the funds are not touched until the account holder reaches retirement age and the holder and employer continue to contribute. While 401(k)s are for employees of for-profit companies, there are similar plans for non-profit organizations (403(b)s), and for state and local government employees (457(b)s). These numbers all refer to portions of the federal tax code, since the plans are allowed to grow on a tax-deferred basis.

Under these plans, employees make a tax-deferred deposit into an account. In the best plans, the company makes annual matching donations to the employees’ accounts, typically in some proportion to deposits made by the employees themselves. Many of the best plans match 100% of employee deposits, up to 6% of wages. A number of companies have raised the percentage of pay automatically diverted to 401(k)s to 10%. (One of the most generous plans of all is for members of Congress—with a 200% match of deposits by congressional participants.) More typically, a good plan will match one-half of employee deposits of up to 6% of wages. However, some plans do not call for the employer to make a matching deposit at all. Other plans call for a matching contribution to be made at the discretion of the firm’s board of directors. Actual terms of these plans vary widely from firm to firm. Also, employers have the right to stop or reduce their matching deposits, which many did during the massive Coronavirus-related economic slowdown of 2020.

Generally, these savings plans allow employees to deposit as much as about 10% of wages into the plan on a tax-deferred basis, subject to an annual maximum. (Participants who are 50 years of age or older may be allowed to make larger “catch up” contributions.)

However, the portion that the employer uses to calculate its matching deposit is generally set at a maximum of 6% of salary or wages. Employees should take care to diversify the holdings in their 401(k) accounts, and most people should seek professional guidance or investment management for their accounts.

Employers typically hire outside firms to handle the management of 401(k)s. Employees are often unaware of annual fees relating to those accounts and the impact of such fees on their net investment returns.

As the U.S. population ages, more and more 401(k) holders will be in a position each year to rollover their funds upon retirement. As a result, brokers will require greater expertise in retirement benefits management. Companies such as Merrill Lynch are promoting professional designations of specialty in retirement planning and benefits. In addition, brokerage houses are offering new products and services aimed at this market.

Unfortunately, despite the fact that 401(k) savings plans have been available for a long time, most workers have low balances that will be inadequate for their true retirement needs. Another concern is that more and more workers are employed by companies that do not offer 401(k) plans. (Many observers find the 401(k) system to be poorly designed, and numerous suggestions have been offered to create a more effective system. Recommendations for reform to retirement savings come from a wide variety of sources.

Many U.S. states require employers that do not offer retirement plans to offer employees access to state-sponsored savings plans. Those employees will be automatically enrolled in individual retirement accounts invested in mutual funds. (However, employees may choose to opt out.)

Internet Research Tip: Employee Benefit Plans

An excellent source for research on employee benefits, including savings plans and health care coverage, is the Employee Benefit Research Institute, www.ebri.org.

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