Benefits and Compensation

Pension Protection Act’s 401(K) Automatic Signup Provision Brings Unintended Consequence

A study shows that the 401(K) automatic sign-up brings in more participants, but of lower quality. Here also is a tool to track developments as the law goes into effect.

A recent Advisor article summarized key changes to company retirement plans brought on by the Pension Protection Act of 2006 (PPA). One is that now companies can automatically sign-up workers for 401(K) accounts unless they actively opt out of enrollment.

The automatic sign-up provision was designed to put the “inertia” factor on the side of participating in these plans, with one target being younger workers, many of whom don’t start serious contributions until far later in life than they should.

According to a survey by HR consultant Hewitt and Associates, the plan has worked. Companies with automatic sign-up show 90 percent of workers enrolled, compared to 68 percent at those with voluntary signup. But there also was an unintended consequence: A reduction in the quality of contributions of automatic sign-ups.

“Employees who are automatically enrolled tend to stick with the employer-provided default contribution rate,” says Hewitt’s Pamela Hess, “so simply getting into the plan isn’t going to help them meet their retirement needs.” She says companies should couple automatic sign-ups with a higher company contribution, which will force employees to raise their contributions. Hess also advises having contribution rates from both parties automatically increase as a worker ages. “That will help get them to a better savings rate over time,” she explains.

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