How your company may be hurting your retirement savings

Auto-enrollment introduces millions of Americans to the concept of saving for retirement — but it’s not enough of a good thing.

More companies are implementing automatic enrollment, in which new employees are signed up for a retirement plan, such as a 401(k) or 403(b), when they start their jobs. The money comes out of the workers’ paycheck, just as it would if someone decided to open up a 401(k) on their own. Some organizations are even incorporating auto-escalation, where the employee’s contribution rate is increased every year.

The concept is extremely helpful for Americans, many of whom are not properly preparing for retirement. Workers are more likely to stay in a retirement plan if they have one created for them, as opposed to them having to take the initiative to meet with Human Resources and get the plan created with an investment firm by themselves. Richard Thaler, a professor of behavioral science and economics at the University of Chicago Booth School of Business, won the Nobel Prize in economics last year for his research on automatic enrollment, and his fellow researcher Shlomo Benartzi said the concept has helped employees save almost $30 billion in the last decade.

The caveat: While auto-enrollment is a good start, it’s just that — a start, and Americans may still not be saving enough for retirement. “We generally find that the minimal amount that a company auto-enrolls is not enough to help secure retirement for employees,” said Dave Alison, a financial adviser at Alison Wealth in Palo Alto, Calif.

More than three-quarters (77%) of employees would stay in a public-sector supplemental retirement plan if they were automatically enrolled, according to a Center for State and Local Government Excellence study, and many said they would change how much they contributed to the plan. The 400 full-time state and local governments workers surveyed were given the option of being automatically enrolled with a default contribution rate of 1%, 4% and 7%. Almost half said they would change the default rate: Those in the 1% group would increase the rate to an average of 5.4%, those in the 4% group would increase to an average of 6.6% and those in the 7% group would increase it to 7.6%.

Although the changes are in the right direction, they’re not enough to provide a comfortable retirement, experts say. Some financial advisers suggest Americans save about 15% to 20% of their gross income (which is pretax). Saving 18% would allow individuals to make their 401(k) similar to a pension, with 2.5% withdrawals for 20 years, said Leon LaBrecque, a financial adviser at Sequoia Financial in Troy, Mich. “If you want income replacement, you need to contribute about 18%,” he said. But that’s daunting, he noted, so he suggests starting at 3% and increasing the contribution one or 2 percentage points each year. Many other advisers said 20% should be the starting point.

Try these tips, advisers said:

Meet the match

Workers also need to consider a company match, and aim to meet that contribution rate if possible for the “free money,” as well as how their retirement plan will be taxed, Alison said. Traditional plans are funded with pretax money, but then taxed at withdrawal, whereas Roth accounts are funded with after-tax dollars but grow and are withdrawn tax-free.

Think about other goals

Auto-enrollment would be even better if companies offered employees the ability to defer some of their salary into nonretirement savings accounts, said Laura Varas, founder and chief executive officer of research and analytics firm Hearts & Wallets. Workers want to save for their children’s college or a house, and may have a hard time balancing that with saving for retirement. If they’re encouraged to save only in a retirement plan — and to contribute so much of their paycheck to that account — they may end up withdrawing from it too soon, which will incur taxes and penalties, and thus lower their investment earnings potential come retirement.

There is no standard answer to how much someone should save for retirement, which is based on numerous factors including projected retirement age, desired lifestyle in retirement, income sources and existing savings, said Leyla Morgillo, a financial adviser at Madison Financial Planning Group in Syracuse, N.Y. Some people also can’t balance saving as much of a fifth of their salary toward retirement when they have other more immediate savings goals and spending obligations, such as rent or a mortgage, groceries, student loans and children’s education or maintaining a business. “For those that can’t yet increase to that amount, one strategy to consider is sending 100% of bonuses or other one-time pay events to their retirement accounts,” she said.

Diversify your retirement plans

Individuals should also think about using numerous retirement accounts for tax purposes, including individual retirement accounts and health savings accounts. “Leveraging something like auto-enrollment into a retirement plan through work is a great way to start working toward that percentage, but you don’t want to throw everything you have into something like a 401(k) — which means it’s OK if the default savings rate through the auto-enrollment option is ‘too low,’” said Eric Roberge, a financial adviser and founder of Beyond Your Hammock in Boston.

Sign up for auto-escalation or do it yourself

Workers should sign up for automatic escalation if it’s not a default option upon starting a new job, and if that’s not a possibility, they should make it a point to increase their contribution rate once a year, such as at the beginning of a new year or right before receiving a raise. “How much money you save and how early you save it are two of the biggest determinants of how much you will have for retirement,” said Edward Snyder, a financial adviser at Oaktree Advisors in Carmel, Ind. “You have control over both.”

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