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August 01, 2005 at 04:00 AM
As members of Congress introduce legislation supporting the adoption of automatic enrollment among companies’ 401(k) plans, a new study by the Investment Company Institute (ICI) and the Employee Benefits Research Institute (EBRI) shows that such a mechanism could significantly increase saving levels for workers of all income levels–particularly low-income employees.
With automatic enrollment, an employee is enrolled in a company’s 401(k) plan unless he opts out. The employer decides on a contribution rate, and allocates the contribution into default investing options, which are typically money market funds or lifecycle funds.
The ICI/EBRI report notes that “the effects of automatic enrollment on income replacement rates at retirement depend heavily on the default contribution rate and default investment option that the plan sponsor selects.” The higher the default option, the higher the replacement rate at retirement, the study says. The study found that 401(k) plans using a lifecycle fund as the default option generate higher income replacement levels than plans that use money market funds. Lifecycle funds invest more aggressively in equities when workers are young and shift to more conservative investments as they age.
The ICI/EBRI study is based on a model developed by ICI and EBRI called the 401(k) Accumulation Model. The model examines how 401(k) assets might contribute to retirement income for future retirees based on decisions workers make throughout their careers: whether to participate in a 401(k) plan, how much money to contribute, how to allocate assets, whether to pull money out of a plan before retirement, and whether to roll over plan assets when changing jobs. According to the study, only 37% of younger employees earning lower wages contribute to a 401(k), whereas 90% of older, higher-income employees contribute to one.
