The potential downside of automatic enrollment in 401(k) plans

The practice boosts employees' savings rates, but it may also increase their consumer debt, according to new research

Dec 1, 2016 @ 1:36 pm

By Greg Iacurci

Automatic enrollment has become a staple of 401(k) best practices over the past decade, touted as a way to boost important metrics such as plan participation and savings rates among employees.

Adoption has more than doubled since 2006, when federal law incentivized employers to use automatic enrollment. Now roughly 52% of all 401(k) plans use the feature, according to the Plan Sponsor Council of America.

However, new research suggests the effects of auto enrollment on participants aren't always rosy.

While the practice of automatically enrolling employees into a company retirement plan does boost savings, it's also correlated in some cases with increased consumer debt, serving as a counterbalance to savings benefits.

“We all pat ourselves on the back” due to an increase in 401(k) plan balances, said John Beshears, assistant professor of business administration at Harvard Business School and co-author of an upcoming report examining this dynamic. Those “large increases in plan balances” are in some cases “being financed by increases in debt.”

(More: 401(k) plan designs hurt employees' ability to save)

Mr. Beshears and others, including David Laibson and Brigitte Madrian of Harvard, examined U.S. Army civilian employees automatically enrolled into the federal Thrift Savings Plan, and found their debt offset 37% of total auto-enrollment contributions over a four-year period.

Although there's still a positive net wealth, it's “almost entirely due to the employer match,” Mr. Beshears said Wednesday at the Defined Contribution Institutional Investment Association's annual academic forum in New York.

Excluding employer contributions, employees increased their debt by the amount of their own contributions, Mr. Beshears said.

The U.S. Army defaults civilian employees into a U.S. Treasury fund at a 3% contribution rate. It matches 100% up to the first 3% of deferrals and 50% of the next 2%. There's an additional 1% non-contingent employer contribution.

Because researchers only looked at consumer debt and excluded in-service withdrawals, plan loans and any outside assets, the crowd-out may actually be greater than measured, he said. Researchers measured debt using year-end credit records from the national credit bureau.

Jack VanDerhei, research director at the Employee Benefit Research Institute, called the study “groundbreaking,” because it's the first one seeking to look at automatic enrollment and its effect outside retirement plans.

However, he cautioned against extrapolating the data to the universe of 401(k) plans, because it measures one plan over a short period of time.


401(k) advisers stress that automatic enrollment remains a beneficial plan design feature. However, they acknowledge the savings-debt dynamic among plan participants.

“We've used inertia to impact their retirement savings, but with the lack of addressing the lack of education or basic financial stewardship skills, it's a net-zero gain,” said Jason Chepenik, managing partner at Chepenik Financial. “We only talk about half the story.”

Mr. Chepenik feels the issue is largely psychological — employees feel more empowered to spend more and rack up debt if they now have savings they didn't have previously.

“It's a whack-a-mole game. We whack one mole and another pops up,” he said.

Jania Stout, practice leader and co-founder of the Fiduciary Plan Advisors group at HighTower Advisors, believes debt will grow to be a larger problem for auto-enrolled employees, absent any sort of “heavy education” programs to tackle budgeting and debt reduction.

The participant debt issue is attributable to the rise of auto-enrollment and health savings accounts coupled with a high-deductible health plan and increasing mobility among employees, Ms. Stout said.

If participants don't save in their HSA and properly budget for higher out-of-pocket costs associated with high-deductible plans, they may finance health costs with debt, Ms. Stout said.

And when an employee changes jobs after a few years with a small 401(k) balance, they may take a distribution to pay off debt rather than roll over the money, she said.

Perhaps contrary to popular belief, mid-salary employees (in the range of $50,000-$100,000) rather than lower-income workers are often the group seeking out budgeting help with consumer debt and student loans, Ms. Stout said. Mid-salary employees have more opportunities to acquire consumer debt, she said.


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