Autopilot for better pensions
It is generally acknowledged that Americans save too little for their retirement and that they know they should save more. But very often good intentions get lost because choices are difficult to understand or inertia prevails. To rectify poor levels of personal contribution a new solution is gaining ground: the ‘autopilot plan’, or the automatic enrolment in 401(k), which entails automatic contribution increases and automatic investment strategies. Behavioural researchers, economists, consultants and 401(k) providers are all pushing in this direction, and a growing number of US companies are implementing such plans. Furthermore, Illinois Republican Rahm Emanuel recently introduced a bill in Congress to support ‘autopilot’ schemes.
American policy makers are worried. According to the Fed chairman Alan Greenspan, by 2050 social security benefits will represent only 30% of a typical worker’s last wage, making the accumulation of private retirement savings urgent. In 2001- according to Fed data - a typical 55-64 year old worker has only $42,000 (e32,600) in his 401(k) and IRA accounts, enough for a meagre annuity payment of $200 a month. The Brookings Institution has figured out that although two-thirds of workers on company payrolls sign up for the 401(k), many start too late and contribute too little. The result is that the median balance of the 60m 401(k) plans in the US is $50,000, but half of households headed by 50- to 59-year-olds have $10,000 or less in their accounts. “There’s a quarter to one-third of families that are not even in the game,” says William Gale, economist at the Brookings Institution.
The Brookings itself is one of the strongest supporters of the automatic 401(k), which is made up of three key features: automatic enrolment, which enrolls all eligible workers in the plan unless they take the trouble to opt out; automatic escalation, which increases employee contributions in a predefined way over time, as a share of earnings; and automatic investments in balanced, prudently diversified and low-cost vehicles, whether broad index funds or professionally managed funds, unless the employee makes other choices. Automatic enrolment alone could boost the rate of 401(k) plan participation to 85-95%, according to a study mentioned by the Brookings Institution.
Currently only 14% of US large companies have embraced some kind of automatic plan and just 1% has adopted a full autopilot design. The reasons are regulatory uncertainties, fears over being sued by workers if they put them into too aggressive investment options and concerns about additional costs. But a survey by benefits consultant Hewitt Associates suggests that the percentage of large companies offering automatic 401(k) plans could soar to 59% next year.
Vanguard is the 401(k) provider most committed to automatic enrolment. Last year it introduced ‘one step’, and eight of its clients have already implemented it (another 20 firms are expected to adopt it by year’s end). One of them is the Australian mining company BHP Billiton. Its new US employees are automatically enrolled in the 401(k) plan and defaulted into a managed account that invests in a mix of funds and, effective from this July, employee contributions will be automatically increased by 1% a year, while the existing 1,800 workers who are eligible for the plan will have a chance to sign up for its automatic version. Another 250 Vanguard clients have added automatic savings increases as a voluntary benefit to their employees.
Fidelity Investments and Principal Financial Group are also big players in this new field. The latter has launched ‘step ahead’ and the former offers the ‘annual increase program’: both allow workers to automatically increase their 401(k) deferrals over time, typically at a rate of 1-2% annually.
Principal Financial Group, adviser to Texan oil refinery Alon’s 260 employees, has also changed its 401(k) plan, making enrolment automatic and hiring PFP to help workers choose from among the 11 different mutual fund options. The effect has been dramatic, says Eric Nystrom, Alon’s manager of benefits and payroll: under Alon’s old 401(k) only about 40% of the company’s workforce signed up; now 80% are participating in the retirement plan.
The department store chain JCPenney also has shifted to an autopilot plan, hiring Financial Engines as an independent adviser to its plan members. Financial Engines has recommended that most JCPenney employees trim their company stock exposure to 20% or less. With the new Philips Electronics North America’s 401(k) plan, workers who do not choose their own asset allocation are automatically put into ‘lifestyle’ funds, which may invest 90% of a 25-year-old’s assets in equities, being reduced to 50% by retirement.