For employers with 401(k) plans, auto enrollment is growing, and target-date funds are an increasingly popular default option. But concern is building over what happens when the two trends meet.

Of those companies that auto-enroll workers, 39% auto-enroll new employees and 18% auto-enroll all employees, according to a survey released Wednesday by Towers Watson. Three percent of the companies polled said they planned to start auto-enrolling by 2011, and 18% said they were thinking about it.

Target-date funds, meanwhile, are the No. 1 default investment option for 401(k) plans. Nearly three-quarters of employers use target-date or "lifecycle" funds this way, and 78% of those using target-date funds as their default option have selected funds not affiliated with their record keeper. The survey, conducted between April and May, polled 334 companies that have at least 1,000 employees.

Mike Alfred, the chief executive of BrightScope, which rates 401(k) plans, said there has been a trend toward auto-enrollment since 2006. He doesn't think it's a good idea for plan sponsors to auto-enroll in target-date funds.

"If you're not going to have a pension plan, but you still want your employees to have a retirement, at some point you have to make sure that employees are participating in 401(k)s. It's a mathematical thing," Alfred said. "But target-date funds are a huge concern of the Department of Labor and the Securities and Exchange Commission right now, both because of how they're marketed and the process used by employers to evaluate and choose the plans."

Alfred said that most plan sponsors don't really have a process to pick 401(k) plans for the employees and even if they do they don't have a real choice at the recordkeeper level.

Generally, the providers tie the hands of employers by forcing them to pick their funds. "The problem then is if you are auto-enrolling into plan funds and you're a plan sponsor, you have a fiduciary responsibility, but you don't really have a choice," Alfred said. "If something goes wrong for participants, they're in trouble. But you as a sponsor can have trouble as well if you have a fiduciary breach or violation."

The Labor Department is devising a checklist to help plan sponsors evaluate and choose target date funds, Alfred said. But the plan sponsors may follow that checklist and find the funds from their providers don't fit the criteria. "So either the plan sponsors leave the providers or providers become more flexible in offering other target-date funds in their plans," he said.

"Evaluating target-date funds is critical for employers, particularly as the number of plan sponsors that use these funds as their default option for workers who are automatically enrolled in 401(k) plans continues to grow," said Sue Walton, senior investment consultant at Towers Watson. "Choosing and developing the most appropriate target-date fund strategy will be crucial for employers to help their employees save for a secure and comfortable retirement."

To be sure, target-date funds are not the only option for employers. The use of lifetime-income options such as annuities has been drawn much attention.

The survey found that only 18% of employers either offer annuities to participants or plan to do so this year or next.

But 30% were considering offering this option. However, 79% of the employers that offer annuities as an option said that only 5% or fewer of their plan participants choose it.

Although annuities can provide a sustained retirement income that can help retirees' throughout their lifetimes, they are much less widely used in 401(k) plans than in pensions and defined-contribution plans, said Robyn Credico, senior retirement consultant at Towers Watson.

Of those employees who were auto-enrolled in 2009, few declined to participate after they were enrolled, the survey found. Eighty-five percent of companies said that less than 10% of employees opted out of the 401(k) plan.

A BlackRock survey report released Tuesday found that employees depended heavily on their companies' matching contributions to steer their own savings goals: 45% of respondents said the employer's matching contribution was "very influential" on their saving habits.

Here's the problem: When asked what they thought a good rule of thumb for a savings rate is, 40% said 10%, and 25% said 12%. But the average contribution rate for employees is about 6% to 7% — or roughly what the normal employer match tends to be.

"We're not out of the woods in terms of the Great Recession, so in the next couple of years we may see a trend of restoring matches actually reverse itself," Alfred said.

Paul Menchaca contributed to this story.

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