How Automatic Enrollment in 401(k)s Could Reshape Saving for Retirement

There soon could be a tool that pushes more Americans to enroll in 401(k)s.

In early May, Reps. Richard Neal, D-Mass., and Kevin Brady, R-Texas, introduced the Securing a Strong Retirement Act of 2021, which aims to boost retirement savings and builds upon changes implemented under the Setting Every Community Up for Retirement Enhancement Act of 2019, or SECURE Act.

This latest proposed legislation, nicknamed the SECURE Act 2.0, currently has a provision that would require employers to automatically enroll eligible workers in 401(k) and 403(b) plans and then increase contributions every year. Proponents argue that auto-enrollment could bolster the amount Americans save for retirement. However, there are concerns that the policy could hurt low-wage earners who can’t afford to reduce their monthly take home pay.

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“I think this forced savings can be a great thing,” says Lauren Lindsay, a financial planner at Beacon Financial Planning in Hyannis, Mass. “Where it can be problematic is for someone who is living paycheck-to-paycheck and cannot afford a retirement contribution.”

The current version of the SECURE Act 2.0 would require employers to automatically enroll eligible workers in 401(k) or 403(b) plans starting at 3% of their salary. This amount would then automatically increase by 1% each year until the employee contributes 10% of their earnings.

Businesses with fewer than 10 employees, businesses which opened less than three years ago, and retirement plans for churches and government agencies would be exempt. Employees could also opt out of contributing to the retirement plan or select to contribute more or less.

Proponents are hopeful that the provision would increase 401(k) participation rates and raise the amount workers save for retirement, as many Americans struggle to save enough. A quarter of working adults have no retirement savings and fewer than four in 10 believe their retirement savings are on track, according to the Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2019.

Auto-enrollment could also play a role in raising participation among groups who’ve historically lagged in retirement saving. A 2012 Ariel Aon-Hewitt Study shows that the adoption of auto-enrollment led to “dramatic increases” in participation for African-American and Hispanic low-wage earners. For African-American workers in lower salary brackets, participation rates increased from 45% to 79%, and for Hispanic workers in lower salary brackets, rates increased from 41% to 80%.

“Though enrolling in a 401(k) involves simple tasks––filling out a form, signing a document––behavioral science research indicates that people need a nudge,” says Anqi Chen, a research economist at Boston College’s Center for Retirement Research.

Auto-enrollment could ensure more workers save for retirement since they would actively have to take steps to opt out of the plan. This “little bit of friction” could prevent at least some workers from taking that step, says Michael Kelly, president and financial planner of private equity firm Switchback Financial in Madison, Conn.

The proposal could also force employees to prioritize future gains, says Jeffrey McDermott, founder and CEO of Create Wealth Financial Planning in Saint Johns, Fla. “Auto-enrollment helps overcome our bias to underweight the importance of things in the distant future, such as having a solid level of assets to retire on,” he says.

However, the auto-enrollment proposal in the SECURE Act 2.0 may have a limited impact since many employers already offer this. Sixty-nine percent of companies already automatically enrolled their workers into a 401(k), according to 2019 data from the Plan Sponsor Council of America. Additionally, 69% of defined contribution plans offered an "auto escalation" feature to increases an employee's contribution rate.

There is also a chance that auto-enrollment could hurt low-wage workers in tight financial situations. Almost two-thirds of Americans say they’ve been living paycheck to paycheck since the COVID-19 pandemic hit last year, according to an October survey by information technology firm Highlands Solutions.

“Many low-income earners may be living paycheck to paycheck simply to meet their basic needs,” Kelly says. “In these situations, it means that the 3% going into their 401(k) can’t simply come from cutting their Netflix account or not eating out that extra night. They need that 3% for food, utilities, and rent or mortgage.”

The financial insecurity of employees with slow-growing income may also be compounded by auto escalation. If a worker's income cannot keep pace with increases in contribution rates, then auto escalation could pull dollars away from goals such as building an emergency fund or paying down debt.

Workers could opt out of contributing or the automatic increases. The process should be easy – returning the appropriate form before the deadline – but for some workers that could add more stress to an already hectic schedule. “That's relatively easy for most people, but if you're stretched thin or you don't understand what the disclosures are telling you, you might not get around to doing it on time,” says Justin Pritchard, a financial advisor at Approach Financial Planning in Montrose, Colo.

Employers could be forced to invest in new human resources platforms or pay to upgrade existing ones since some current systems are set up to opt workers in, rather than out, of contributing to a retirement plan. Tracking employees who opt out – rather than into plans – could become especially difficult for industries, such as restaurant, transportation and service sectors, with higher worker turnover.

Additionally, low-wage workers may be more likely to ask to withdraw money or to take a loan from the retirement plan, furthering administrative burdens and costs, says Kirk Kinder, founder and president of Picket Fence Financial in Clearwater, Fla. That could eventually force some employers to stop offering a retirement plan or choose a “turn-key, low effort plan,” he adds.

Mid-year job switchers could feel an additional burden, says Nate Nieri, founder and owner of Modern Money Management in San Diego, Calif. You need to keep track of your retirement plan contributions made before switching to a new employer to avoid going over those limits. If an employee contributes too much to a 401(k) plan, they may need to unwind contributions and possibly pay stiff penalties.

Although the proposal could help Americans save more for retirement, it won’t necessarily be a panacea. A majority of Americans struggle with financial literacy – two-thirds can’t pass a basic financial literacy quiz, according to a 2019 study by FINRA Foundation Research. Employers should take an active approaching to addressing this as well, says Mark Struthers, a financial planner at Sona Wealth Advisors located in St. Louis Park, Minn.

“The whole point of this [bill] is to change behavior and put employees in a good position to succeed. A high 401(k) balance means little if they have a 500 credit score, a negative net worth, and are paying 24% on a credit card,” Struthers adds. “If employers want financially healthy employees, they need to educate, guide and coach.”