Should Retirement Plan Sponsors Implement Automatic Enrollment?

Use of automatic enrollment in defined contribution plans has grown considerably in recent years as plan sponsors seek to boost employees’ participation and retirement savings. Concerned about the fact that only 32 percent of workers nationally who have access to a 401(k) or 403(b) plan participate, employers are moving to automatic enrollment out of a sense of responsibility.

By 2017, 64 percent of all DC plans have implemented some form of automatic or simplified enrollment, according to J.P. Morgan. Half of those plans included automatic contribution escalation. Plan sponsors considering adopting automatic enrollment too should understand the decisions involved and the pros and cons of auto enrollment before moving forward.

Plan Design Options

More plan sponsors define their retirement savings plan objectives in terms of retirement outcomes and proactively helping employees toward a secure retirement. A basic automatic enrollment arrangement allows them to “enroll” eligible employees to contribute a default percentage of pay, unless the employee chooses to opt out or chooses a different contribution level.

There are two pre-approved forms of auto enrollment used by employers:

• An eligible automatic contribution arrangement (EACA) is similar to the basic auto-enroll plan but includes notice and withdrawal requirements. EACA participants can opt out of the plan and withdraw any funds accumulated within 90 days of their first contribution without incurring a tax penalty.
• A qualified automatic contribution arrangement (QACA) establishes a default contribution level of at least 3 percent of the employee’s compensation. The contribution level then automatically increases 1 percent per year to a minimum of 6 percent. Automatic employee contributions cannot exceed 10 percent of eligible pay. Many plan providers are setting up their QACA as a safe harbor 401(k) plan. To qualify as a safe harbor plan, the plan must provide a fully vested matching contribution. Employees can change their contribution level or choose not to contribute. However, some 401(k) plans provide employer contributions to all eligible employees, even if they opt out of contributing, to ensure a safe harbor.

Plan sponsors setting up automatic enrollment need to choose a fund into which employees’ contributions are invested until the employees change the investment choice. The default investment fund is typically a target date fund (used by 62 percent of all plans) or a balanced fund.

Proactive Participation Versus Potential Issues

Research indicates that automatic enrollment boosts plan participation. The IRS reported that studies suggest auto-enroll adoption could cut the nonparticipation population to about 15 percent. That figure may be optimistic, but evidence does support the effectiveness of automatic enrollment. Bank of America Merrill Lynch reported that their clients with auto-enroll plans garnered 78 percent new employee participation. They reported a 53 percent participation rate for plans using traditional enrollment options.

The challenge is retaining the participation of new hires over time. Several studies have looked at inertia in participant behavior. A substantial number of those new hires added via automatic enrollment stick to both the default contribution rate and fund option, according to the National Bureau of Economic Research.

That may not always be the case. Many public employees added through automatic enrollment in South Dakota’s supplemental retirement saving plan did not stay with the plan. First-year participation rates in 2010 for government employees in the state exceeded 92 percent. However, by 2016, participation for those workers fell to 80.5 percent. Many companies offer a generous company match as an enticement to stay in their plans.

A drawback to simplified enrollment affects plan sponsors with a high employee turnover rate or a low-paid workforce. Auto-enrollment for them results in numerous small accounts that can result in administrative issues and increase plan costs. Record-keepers base plan sponsor expenses on the average participant account balance, with lower amounts translating to higher costs. Plan sponsors may not want to cash out participants. A sponsor with high turnover may opt for auto-enrollment after 90 days. However, auto-enrollment works best when people do not become dependent on having the money in their paycheck. Taking home less after 90 days is not likely to be popular.

Looking Ahead

A bill in Congress would require most employers with at least 10 employees to offer either a 401(k) or 403(b) retirement savings plan and automatically enroll their employees. The measure, which grandfathers existing plans for eight years, would require firms to defer at least 6 percent of workers’ eligible pay and include automatic escalation. While the bill may not pass, it reflects the growing concern about the need to boost retirement savings.

Plan providers looking for better outcomes and improved retirement readiness for their employees may want to take a look at potential plan design changes, automatic enrollment options and whether to implement a safe harbor plan. Working through the design, match and investment menu usually requires help from a professional.

Receive Expert Help

PlanPILOT is an independent Registered Investment Advisor, not affiliated with any investment banks or funds. We help clients evaluate ways to improve the effectiveness of their benefits plans and meet the plan provider’s and participants’ needs. Give us a call at (312) 973-4911 or email info@planpilot.com to find out how we can partner with you to improve your retirement savings plan and its participation rates.

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