Retirement Savings Should Not be Left on Autopilot

When participating in a 401(k) plan, there is a fine line between investing intentionally with long-term holdings and “set it and forget it.”

401(k)s are wildly popular among defined contribution plans because they have high contribution limits; when offered, an employer match is an instant gain; deferrals are on gross compensation before taxes are withheld on paychecks; growth is tax deferred until withdrawn, and most plans have quality investment options.

Legislation has made them more attractive by allowing employers to automatically enroll employees. In physics, force is required to overcome inertia—i.e., standing still. Likewise, automatic enrollment forces employees to begin saving. While employees are always given the option to decline, nine out of 10 employees automatically enrolled as new hires remain in their employer’s plan, according to research from Vanguard Investments.

However, most companies auto enroll at low contribution levels—generally 3% or less. For most investors, a set-and forget-3% contribution rate is likely not enough to retire on. Even if an investor follows the general guidance of contributing enough to get the full employer match, that may only be 5% of compensation. If an employee is with a company for several years and receives cost of living raises, performance raises, and promotions with pay increases, that 5% contribution rate sweeps more money into the retirement account; however, the employee is also learning to live on more money. Again, it is likely that 5% over a 40-year career will not yield enough to fully support a retirement lifestyle. It is still the employee’s responsibility to increase their contributions, select appropriate and diversified investments, and take advantage of Roth options if available in their plan.

Furthermore, we just experienced the longest bull market in history. Likely, anyone contributing just 5% saw healthy growth their retirement balances—even if they were in an index fund or a target-date fund. Unfortunately, an 18.26% annualized return, as we’ve seen since the end of the Financial Crisis in 2009, is not normal. Over an extended period, markets generally gain around 10% annualized. At Henssler Financial, we encourage most investors to save 10% to 15% of their pay for retirement. We generally like to see Roth options used, when available, which provide tax-diversified retirement funds.

The Secure Act 2.0 will require employers to automatically enroll new hires at a 3% of compensation contribution with automatic increases by 1% each year until it reaches 10%. While this should substantially improve retirement savings, keep in mind that this is for new hires. If employees have been with their company prior to the roll-out of this law, auto-enrollment and auto-increases may bypass them. Likewise, if younger employees change jobs every three years, they may never increase to more than a 5% contribution rate.

Despite strides to increase automatic retirement savings, employees should not “set and forget” their 401(k). Saving for retirement requires some active decisions. The bottom line is investors need to know what savings rates will help them reach their goals. As income and goals change, savings rates and investment choices may need to change too.

If you have questions on how to begin shifting your asset allocation for retirement, the experts at Henssler Financial will be glad to help: