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Study: Auto 401(k) Saving Leads to More Debt

January 8, 2018

The attempt to get more Americans to save for retirement through automatic enrollment in 401(k) plans may lead workers to take on more debt, according to a recent report cited by the Wall Street Journal.

Many workers enrolled in such plans sabotage their long-term savings by getting into more mortgage and auto debt than they would if they weren’t auto-enrolled, according to the report co-authored by James Choi, a professor of finance at the Yale School of Management, the Journal writes. Choi and his colleagues looked at savings and debt levels of 32,073 civilian employees the U.S. Army hired before the the implementation of automatic enrollment in its Thrift Savings Plan, which is similar to a 401(k) plan, and at 26,803 civilians the army hired after auto-enrollment was implemented, according to the paper.

The study found that employees who were auto-enrolled had an average of $1,563 more in consumer and auto debt than those who were hired before auto-enrollment, the Journal writes. And workers who were auto-enrolled on average owed $4,131 more on their home mortgages than those hired before auto-enrollment, the study found. That level of debt offset the additional $3,237 in amassed 401(k) contributions auto-enrolled workers had on average compared to those hired before auto-enrollment, the paper writes.

The problem could be widespread. Since the late 1990s when regulators began enacting legislation to promote auto-enrollment plans, the number of employers with such plans has steadily grown. While only 34% of large employers offered them in 2007, that percentage grew to 58% in 2015 and 68% today, according to data from 401(k) record-keeper Alight Solutions cited by the Journal.

The silver lining is that workers who are auto-enrolled don’t take on more detrimental, higher-interest debt such as credit-card debt, installment loans or second mortgages, Choi tells the paper. What’s more, the additional debt doesn’t lead to lower credit scores, the Journal writes. And taking on more debt in the form of bigger mortgages may even raise the workers’ net worth in the long term, depending on the housing and stock markets, the study claims, according to the paper.

Retirement specialists, meanwhile, tell the Journal that steering away from automatic-enrollment 401(k)s would be a mistake. Such plans, despite the new research, are still “a good solution for the vast majority of clients,” Neil Lloyd, head of U.S. defined contribution and financial wellness research at consulting firm Mercer, tells the paper. Lori Lucas, defined-contribution practice leader at Callan, an investment-consulting firm, tells the paper “auto-enrollment is the most successful way to get people into a plan” and the recent research doesn’t undermine it.

But 401(k)s could be hurt as a result of the new 20% tax deduction to pass-through businesses in the Republicans’ new tax law, according to the American Retirement Association, InvestmentNews writes. Small-business owners are disincentivized from putting pre-tax earnings into 401(k)s, since they could then face a higher tax rate upon withdrawal, according to the publication. The tax differential could steer some owners from starting a plan in the first place, Doug Fisher, director of retirement policy at the ARA, tells InvestmentNews. Some types of business, such as S corporations, meanwhile, could have less incentive to match employee contributions,Michael Hadley, partner at lobbying firm Davis & Harman, tells InvestmentNews. But Aaron Pottichen, retirement services practice leader at CLS Partners, says many business owners set up 401(k)s for their employees’ benefit rather than their own, so the final impact on plans “is still to be determined,” he tells Investment News.

By Alex Padalka
  • To read the InvestmentNews article cited in this story, click here.
  • To read the Wall Street Journal article cited in this story, click here.
  • To read the Wall Street Journal article cited in this story, click here.