Automatic Enrollment

*****UPDATE***** Effective for new plans as of January 1, 2024, Automatic Enrollment is mandatory

Introduction

So you’ve spent all this time putting together a 401(k) plan for your employees, who’s participating? It’s fairly common for employees to be excited about a 401(k) but hesitate to actually contribute to the plan. They know it’s the right thing to do but put it off for another time. Automatic enrollment provides a small push to help employees get started. The ultimate decision is still theirs to make.

But wait a minute -- How much time and energy do you want to devote to your retirement plan? Automatic enrollment is hardly a set-it and forget-it type feature. Adding automatic enrollment means adding numerous new requirements with their own deadlines the plan will need to monitor. It also increases the chances for errors. In general, implementing automatic enrollment will generally mean more time and energy spent to maintain the plan.

Once you decide you want to try automatic enrollment, there are lots of ways to accomplish it. First, let’s discuss some advantages and disadvantages to help determine if it’s the right choice for you.

Advantages of Automatic Enrollment

Increased participation in a retirement plan can have a number of benefits:

Plans with more assets can better bargain for lower fees and better services
Helps employees save for retirement; some contributions may be better than no contributions
Employee involvement/interest in and awareness of the plan may increase
The plan’s default investment option may be better diversified than if employees choose their own investments
Helps the plan pass nondiscrimination testing

Disadvantages of Automatic Enrollment

Increased time and energy spent on administering the plan
Increased chance for plan errors
May result in less investment by employees (less research on contribution amounts and investments) since employer does all the work
Default investment may not reflect what employee would have selected
Default contribution rate may be lower than what employees would have selected
Plan may end up with lots of small balances to administer (participants ultimately opt out or do not increase low contribution rates)

Summary – Advantages vs. Disadvantages

Comparing some advantages and disadvantages of automatic enrollment is often like looking at two sides of the same coin. Whether you see a feature as an advantage or disadvantage may simply depend on your viewpoint.

Is it better for participants to invest in the plan’s meticulously chosen, well-diversified default investment? Or is it better for participants to select their own investments?
Does automatic enrollment mean more participants are aware of the plan? Or does it mean participants take less control of their retirement since the selections have been made for them?
Studies have shown that while automatic enrollment will increase overall participation in the plan, contribution rates of those contributing tends to be less. Is it better to have more participation? Or better to have higher contributions from those who do participate?

Overall, an automatic enrollment feature means the plan/plan sponsor is making some choices for the participant. For some employers/employees this makes sense. For others, it can feel too parental/protective.

The choice to include automatic enrollment can also be purely practical – as a way to help pass nondiscrimination testing. Other options include setting up safe harbor employer contributions. Safe harbor contributions can be set up as a minimum matching contribution or a minimum percentage of compensation. Automatic enrollment can also be combined with a safe harbor employer contribution.

Types of Automatic Enrollment

Automatic enrollment can be set up in numerous ways. The plan document will need to set the basic ground rules. There are 3 basic ground rules that typically need to be specified:

What is the default contribution amount? Typically, default contributions are a percentage of compensation. Percentages typically vary from 1% - 10%, with 3% being the most common. Note that most retirement experts suggest deferring at least 10% of income for retirement.
Who is subject to automatic enrollment? Auto-enrollment typically applies to all employees as of the effective date or just employees hired after the effective date.
Does the automatic enrollment amount increase with time? Automatic enrollment can be set up to increase each year or other period of time. The increases could apply to all employees or just those who have not opted out of the program. Automatic increases will tend to greatly increase the complication of administering an automatic enrollment program.

Policies and procedures can fill in the gaps and can change with circumstances and time as necessary. Details like deadlines to opt out of automatic enrollment could be specified in the document or left to administrative procedures. It is also possible to set up an arrangement that allows employees to opt out of automatic enrollment for a short period of time (up to 90 days) after it has begun and receive a refund of contributions that were made to the plan on their behalf.

Notice and Other Requirements

No matter what type of automatic enrollment program is offered, employees must have notice of the automatic enrollment program. If automatic enrollment is combined with a safe harbor program, the notice must be provided annually within certain time-frames. Participants must have an effective opportunity to elect to receive an amount in cash or have that amount contributed by the employer to the plan. Failures tend to arise from not timely following a participant’s request to opt out of automatic enrollment – or failing to implement automatic enrollment for a new employee.

Summary

Many factors will determine how an automatic enrollment plan is designed. Your plan document may limit the way the automatic enrollment program can be set up. The employee population will help determine how complex the program can or should be. The employer’s desire and ability to manage an automatic enrollment program will also play a large part of the analysis.