Auto enrollment means that your employees are automatically enrolled in your organization’s 401(k) plan. This typically occurs when new employees are eligible to participate in the plan. Auto enrollment may also occur at specified intervals over time for existing employees who are not yet enrolled in the plan. Employees are also able to opt-out if they wish. Although many benefits of auto enrollment are employee-focused, there are several advantages for employers.
Advantages of Auto Enrollment for Plan Sponsors
Increased participation. Auto enrollment is a way to help employees who haven’t enrolled in a plan, started with their retirement savings. Auto enrollment is not limited to new hires, as existing employees are eligible as well. Your employees may have a wide range of experience and knowledge of 401(k) plans. Auto enrollment can help familiarize them with the ease of saving for their retirement; hopefully, your employees are empowered take things from there.
According to one study, participation rates for plans using auto enrollment increased to approximately 92% compared to about 57% for plans not utilizing auto enrollment. By allowing employees to opt out as opposed to opt in, it simplifies the process for both the employer and the employee. The employer-end set-up process is simplified, while the employees are encouraged to consider the benefits of saving for retirement.
Default option. There is generally a default investment option for employees, referred to as a Qualified Default Investment Alternative (QDIA), which typically is a model portfolio or a similar investment option based on a moderate investment risk tolerance. All employees have unique needs, but at the very least, it gets each participant invested in something beyond a money market fund.
According to research by Gallagher, 60% of employees surveyed had positive feelings toward an employer who offered a default option like a target date fund. The same respondents viewed employers offering both auto enrollment and auto escalation, a feature that increases the contribution percentage each year, more positively.
Auto enrollment tax credit. The SECURE Act added a $500 tax credit for plans adding an auto enrollment feature to a new or existing plan. The credit is available each year for the first three years that the auto enrollment feature is available.
Non-discrimination testing. Increasing participation from auto enrollment can help the plan pass it’s non-discrimination testing. Auto enrollment positively impacts the number of non-highly compensated employees participating the plan, that previously decreased the average contribution rate. When the average contribution rate among non-highly compensated is low, due to lack of participation, it directly affects the amount that key and highly compensated employees are able to contribute. Auto enrolling employees that would not traditionally participate will facilitate the success of your yearly non-discrimination tests.
Hands-off. Once the initial set-up is completed, auto enrollment is fairly hands-off as employees meeting the criteria are automatically enrolled in the plan at the default contribution rate and into the QDIA default investment option.
Potential Drawbacks for Employers
Not saving enough for retirement. While auto enrollment does help get more employees started with their retirement savings, often employees leave their contribution rate at the default level, 1-3%, that most auto enrollment plans offer. They may be lulled into complacency thinking this is enough to be saving for retirement, which, in some cases, may result in lower contribution rates than from those who proactively sign up.
Combining auto enrollment with an auto escalation plan that increases the percentage contribution each year can help participants increase their deferral percentage each year.
In considering the best contribution percentage for auto enrollment, plan sponsors need to balance helping participants save a bit more for retirement with the level at which employees might opt-out of the program. In some cases, employers might find that their employees are receptive to a higher contribution percentage, like as much as 6% of compensation. But this is not all cases, so it is important to find something that works for your business.
Cost issues. If your plan offers a match, increased participation will increase the overall cost of your matching program. Of course, some of this will be offset by any tax deductions you are able to take on the matching contributions.
Every plan sponsor’s situation is different. But if you have a population of employees who are not participating in your organization’s 401(k) plan to the extent that you’d like to see, auto enrollment is something to consider.
Auto enrollment gets participants into the plan, but it does not solve the problem of employees not saving enough for retirement alone. Participant education and access to advice can effectively encourage employees to save more and invest in a way that can help them achieve retirement readiness.
Please contact us for more information about auto enrollment for your organization’s plan.
Shelton Capital Management does not provide accounting or tax advice to its clients. All clients should be aware that tax treatment is subject to change by law, in the future or retroactively, and clients should consult with their tax advisors regarding any potential strategy, investment or transaction.
The information provided should not be considered investment advice and does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.