Can Automatic Savings Plans Solve America's Retirement Woes?

By Lisa Backus Markets Fool.com

It's no secret that Americans' retirement readiness is abysmal. According to a 2013 study, more than half of American households won't be able to live as comfortably in retirement as they did while working. Retirees typically need 70% or more of their pre-retirement income to maintain their lifestyles, and Social Security is only designed to provide about half that amount.

Continue Reading Below

Many Americans find themselves struggling in retirement, when they're least able to provide for themselves. Image source: Getty Images.

For the past three decades, more and more employers have been helping to alleviate the retirement crisis by offering 401(k)s. Workers can save up to $18,000 per year in these tax-advantaged accounts (or $24,000 if they're aged 50 or older), and employers will typically match a certain percentage of their employees' contributions.

There are a multitude of benefits to contributing to an employer-sponsored retirement savings plan, including the end game, which is a healthy source of retirement besides a monthly Social Security check.

But there's a hitch: You can only get the benefit of an employee-sponsored retirement savings plan if you actually participate, and millions of American workers pass up the opportunity to save through a 401(k). That's why more and more employers are automatically enrolling their workers in 401(k) plans; those who don't want part of their paychecks set aside for retirement have to opt out.

But what employers have found is that, once people are signed up, they stay signed up, and they are reaping the benefits of setting aside money now to ensure they'll have more than enough when they retire.

Continue Reading Below

What is a 401(k)?

Since their inception in the early 1980s, 401(k) plans, also called defined-contribution plans, have become the primary way people supplement their retirement incomes. You can only access this type of retirement-savings plan through an employer, although states are also jumping on board. Connecticut is about to roll out an initiative allowing residents to buy into a state-run 401(k) plan.

How does a 401(k) plan work? Employees contribute a portion of their wages, with the goal of growing those funds over time by investing them in assets like mutual funds. In many cases, employers will match a portion of the contribution. The contributions, and any interest you gain, are tax-free until you start drawing money from the plan after retirement.

Between your employer's contribution and your long-term commitment to saving through a defined-contribution plan, you'll realize a healthy source of supplemental income by the time you're ready to retire.

What's the benefit?

There's more than one benefit to participating in a 401(k) plan. The money is taken out of your paycheck pre-tax, so your tax liability is reduced up front. Another benefit is that, if your employer is matching some of your contribution into the plan, you'll automatically earn huge "returns" in the form of free cash.

The key to having enough money to supplement your retirement income is to start saving as early as possible.For example, if you save 10% of your $50,000 salary starting at age 25, then you'll have just over $1 million saved by the time you reach age 65, assuming your investments earn a respectable 7%. However, if you wait until age 45, then you'll only accumulate $219,000 by age 65. So if you're behind on your retirement savings, you'll need to save much more aggressively to ensure your future financial security.

Can automatic participation improve retirement for the masses?

Most people are employed up until they reach retirement age, and many employers offer 401(k) plans. So why aren't more people taking advantage of the tax ad "free money" they can reap by participating?

In some cases, it's simple inertia, according to theCenter for Retirement Researchat Boston College. If you have to go out of your way to sign up, then a lot of people won't bother, even though they stand to gain more stability in retirement.

To combat this type of inaction, more employers are automatically enrolling new employees in their 401(k). According to WorldatWork, 37% of the 500 or so employers who took part in the study reported that they automatically sign up their employees and have an 80% to 89% participation rate. Meanwhile, only 21% of employers that did not offer automatic enrollment reported such a high participation rate.

Automatic enrollment tends to allow inertia to work foremployees, rather than againstthem, as studies show that once employees are signed up, they tend to remain in the program.

If your employer offers a 401(k) and you haven't already enrolled, then sign up as soon as possible -- especially if your employer offers matching contributions. If you've been signed up automatically, don't rely on the "default rate" to make sure you're saving enough. According to a 2013 CRR study, employees who remain at the automatic contribution "default rate" -- the lowest contribution amount set by your employer -- risk not saving enough for retirement.Gradually raise your contribution over time, with the goal of eventually saving at least 10% of your salary.

This type of savings plan can make the difference between limping along during retirement and having enough to travel and enjoy your golden years. Don't wait, because you're only short-changing your future self.

The $15,834 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.