Is Automatic Enrollment a Good Fit for Your Organization's Retirement Plan?
We are continually being told that Americans are not saving enough, and that Social Security may not be available in the future. As a result, many employers are looking at ways to encourage employees to save early and often. An automatic enrollment provision is one way you can help your employees save for later in life.
Retirement plans that allow elective salary deferrals (e.g., 401k and 403b plans) can adopt an automatic enrollment feature that allows plan sponsors to automatically deduct elective deferrals from an employee’s wages. Automatic enrollment can help increase participation in your plan, sometimes for purposes of satisfying the Actual Deferral Percentage and Actual Contribution Percentage tests. Although the feature requires employees to defer into the plan, they do have the ability to opt out, or contribute an amount different from the default amount outlined in the plan document.
But before you adopt automatic enrollment in your plan, there is some background work you should do to make sure it will be a good fit for both your employees and your organization.
Automatic enrollment helps employees save for retirement
Based on the recent Report on the Economic Well-Being of U.S. Households in 2016, 28 percent of non-retired adults said that they currently have no retirement or pension savings. The report also revealed that the primary source of income for retirees is still Social Security benefits, which only provide approximately 40 percent of a retiree’s annual earnings. These numbers indicate that the primary reason people don’t have retirement savings is because they aren’t saving early or consistently, and investment returns become secondary to the real issue of inadequate saving strategies.
Most financial planners encourage individuals to save between 10 and 15 percent of their annual compensation toward retirement.
An automatic enrollment provision will designate an initial deferral election and may include an annual automatic escalation feature. The escalation features can encourage employees to save more each year. Based upon the latest study performed by the U.S. Bureau of Labor Statistics, automatic enrollment features yielded over a 9 percent increase in employee participation rates.
Check your qualified default investment alternative
You should start with the basics. You’ll want your plan to have a qualified default investment alternative (QDIA), similar to lifecycle or target date retirement funds that seek both long-term appreciation and capital preservation. As part of the employer’s fiduciary responsibilities, you should ensure that you are offering adequate investment alternatives that are performing consistent with similar sized plans in similar types of investments in the market. This is important, as you want to make sure your employees are not electing to defer more into their retirement plan in underperforming investment options.
Evaluate your organization’s readiness for auto enrollment features
If you are considering auto enrollment for your benefit plan, consult with a peer who has already rolled out the feature to talk about its experience, asking questions like:
- How much did these features increase plan assets?
- What was the participation rate before auto enrollment and post automatic enrollment?
- What was the average participant account balance before auto enrollment and post auto enrollment?
- What participant complaints have been received?
- What percentage of participants are now at or above the target deferral rate (for plans with automatic escalation provisions)?
Prior to implementing this feature, you should also speak with your current plan consultant or third party administrator, who can help you evaluate your current plan and the impact auto enrollment could have should you choose to move forward.
Consider implementation risks
While there are some obvious advantages to using auto enrollment, there are some common challenges organizations face following implementation. Some employers have reported never properly implementing the automatic enrollment provision after adding it to their plans. Others have reported issues implementing on an ongoing basis due to lack of automation, or finding that the automation of the processes does not consider all potential scenarios to properly capture and automatically enroll newly eligible participants. Such errors may result in the employer having to remit a corrective qualified nonelective contribution (QNEC) plus matching contributions (if applicable in accordance with the plan document).
The QNEC is an employer contribution that is intended to replace the lost opportunity for a participant who was not permitted to make the elected deferrals. These errors can be very costly to the employer, who could incur up to 50 percent of the missed deferral plus lost earnings depending on the facts and circumstances. Given the magnitude of the error, employers who have made these errors should consider consulting an Employee Retirement Income Security Act of 1974 (ERISA) attorney.
With increased participation rates also comes increased costs to the employer (e.g., additional matching contributions, additional administration costs, etc.), so it’s important to revisit your fee structure with your plan custodian and advisors prior to implementation.
How we can help
CliftonLarsonAllen’s (CLA) employee benefit professionals are well-versed in automatic enrollment and other important features of ERISA plans. We can help you decide if automatic enrollment would work well with your organization’s structure, and help you get the most out of your plan.