The (Potential) Dark Side to 401(k) Auto Enrollment – The Participants Seem to Take on More Debt

By: David I Gensler, MSPA, MAAA, EA

Auto-enrollment has resulted in millions of people who were not previously putting savings into their company’s 401(k) plan, now actively participating in it. That is a good thing. However according to a recent article in the Wall Street Journal, many of these workers seem to be offsetting those savings over the long term by taking on more auto and mortgage debt. And that may be a good thing as well. (No, the previous sentence is not a typo.)

A study from academic economists who have focused their studies on retirement plans seems to answer a question that has concerned supporters of auto-enrollment since it gained popularity about ten years ago. Do some people – particularly lower income savers – take on more debt to compensate for the reduction in their take home pay?

The article points out that there is “good debt” and “bad debt” (who knew?). The economists found two promising patterns for lower-income auto-enrolled participants in 401(k) plans: the study found no evidence that they are running up more credit card debt (bad debt) and that the extra debt that they are taking on is causing their credit score to deteriorate.

It appears that the additional debt that these folks are taking on is mortgage debt (good debt), which may even boost their credit score. What they do not seem to be doing is taking on the kind of debt that would be worrisome like credit card debt, second mortgages or installment loans. All of those fall into the category of bad debt.

Retirement plan think tanks and policy makers have long been staunch advocates of auto- enrollment. Statistics indicate that 50% of American households are at risk of being unable to maintain their standard of living in retirement. That represents an 11% increase from an earlier study done back in 2004. So the goal has been to sweep in as many people as possible who wouldn’t have saved a penny into their company’s 401(k) plan and let inertia take over after that.

The statistics are compelling. In plans with automatic enrollment, 85% of eligible employees participate compared to 66% in plans that lack this feature.

In a study that tracked about 32,000 employees with an average salary of $55,000 for the twelve months ended on August 1, 2010, it was found that the employees who were auto-enrolled saved about $3,200 more than those employees that were left to their own devices. The study also found that these same employees tended to have mortgage debt of about $4,100 more than the employees who were not auto-enrolled. The study’s authors contend that having a higher mortgage may actually be a good thing because it can contribute to a higher net worth in the long run (although that certainly was not the original intention of auto-enrolling employees). Rob Austin, director of research at Alight, which participated in the study said that it shows that “people have more in their 401(k)s” and possibly “a little bigger house.”

The study did find that the auto-enrolled employees also tend to take on more auto debt and that is a troubling trend. Over the long term, unlike real estate, cars depreciate quickly thus acting as a bigger drag on net worth.

Why do auto-enrolled employees tend to take on more debt? Brigitte Madrian, a professor at Harvard’s John F. Kennedy School of Government and one of the study’s five co-authors, speculated that these participants borrow from their 401(k)s because they may “feel wealthier and able to afford a bigger home.”

All in all, it does seem that even if auto-enrolled participants do tend to take on more debt, the benefits outweigh any of the possible negatives.

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