Automatic Enrollments Stimulate Participation In 401(K) Plans
If you are looking for a way to get reluctant employees to participate in your 401(k) plan, an automatic enrollment program may be your answer. Your employees know they have to begin saving for retirement, but some of them are reluctant to take the first step required to get started. An automatic enrollment program will help them overcome their reluctance.
Most employers have 401(k) plans that allow employees to save for their retirement on a voluntary basis. Most of you have encouraged your employees to participate by offering matching contributions and educational programs, and these efforts usually result in participation by 70 to 75% of the work force.
The challenge for employers, and our society in general, is to persuade the other 25% to 30% of the work force to begin saving for their retirement. They will want to retire someday and Social Security may not provide enough to sustain them when they are no longer able to work.
Our clients have tried to promote additional participation by increasing matching contributions or educational programs, but these incentive programs often increase the employer's cost without increasing participation by the reluctant group. As an alternative to the incentive approach, several of our clients use "automatic enrollment" programs whereby employees who are not participating are enrolled for some level of contributions and the employees must "opt out" if they do not want to participate. A typical automatic enrollment program requires contributions of 3% of compensation for all eligible participants or for all new participants. Some programs increase the automatic contribution rate every year for several years and, in all cases, employees are able to modify the contribution rate or opt out altogether.
Our clients tell us that the automatic enrollment programs have been well received by employees and have increased participation rates to 90% to 95% of their employees. The employees who were reluctant to "opt in" to the 401(k) plan are just as reluctant to opt out.
Automatic enrollment programs can provide some additional benefits for the employer and highly compensated employees. A "safe harbor" automatic enrollment and matching program enables employers to avoid the non-discrimination testing that applies to 401(k) plans and can limit the amount of voluntary contributions by highly compensated employees.
Automatic enrollment programs can be beneficial for all employees. They get reluctant employees into the savings program and increase the contribution level by lower paid employees, and this provides additional opportunities for contributions by highly paid employees whose contributions may be limited by the 401(k) discrimination test. The result is even better with the safe harbor automatic enrollment program.
Safe Harbor Automatic Enrollment Program
Employers can avoid the 401(k) discrimination test that limits contributions by highly paid employees by adopting a "safe harbor" automatic enrollment program. The safe harbor program requires automatic enrollments at certain percentages, matching contributions or "across the board" contributions at certain percentages, and annual notices to employees.
A safe harbor program must cover all employees who meet the eligibility requirements for the 401(k) plan. Eligible employees must be enrolled for contributions of 3% of compensation during their first year of participation, 4% during their second year, 5% during their third year, and 6% in years four and beyond. Of course, employees are able to change their contribution levels or opt out at any point, but they are required to take affirmative action to do so and our clients tell us that most do not do so.
The second safe harbor requirement is an employer contribution of either 3% of compensation for all eligible employees, or matching contributions equal to 100% of the first 1% contributed by the employee and 50% of the next 5% contributed by the employee. The employer contribution is thus 3% using the first approach and a maximum of 3.5% using the matching approach. The employer contributions may be subject to a vesting schedule so that employees forfeit them if they leave with less than two years of service.
The third safe harbor requirement is an annual notice to employees at least 30 days in advance of the plan year to which the safe harbor program applies. The notice advises employees of the automatic enrollment, the matching or other employer contributions, the employee's right to opt out of the program, and investment programs available through the plan.
The "Default" Investment Option
Most 401(k) Plans allow employees to choose from a variety of mutual fund investments for their accounts and include a "default" investment for employees who do not make an investment choice. The default investment choice is particularly important for automatic enrollment programs.
Several years ago, the typical default investment was a money market account. The Department of Labor ("DOL") decided a few years ago that a money market account was not good enough and issued regulations requiring the default investment fund to have some exposure to equity markets and pushed everyone into using a balanced mutual fund or lifestyle or target date funds as the default investment. Ironically, the stock market has tanked a couple of times since the DOL issued the regulations and money market accounts have looked pretty good for the past ten years.
Regardless of whether you decide to institute an automatic enrollment program, you should review the "default investment" in your 401(k) plan on an annual basis when you are reviewing the other investment choices. The selection and monitoring of the default investment is one of your fiduciary duties along with your duty to select and monitor all of the investment choices.
Success of Automatic Enrollment Programs
Several of our clients have had automatic enrollment programs for several years and their experience has been uniformly positive. They tell us that participation rates for their plans have increased to more than 90% and their experience is consistent with the reports we read in the trade journals.
Design and Implementing Automatic Enrollments
There is no set design for an automatic enrollment program except for the safe harbor approach. A typical program starts at a 3% contribution and includes some level of matching contributions by the employer, but you may choose different levels and do not have to include a match. Your automatic enrollment can apply to all eligible employees or just new employees, or just employees who are not already participating at the level of the automatic enrollment.
When you implement an automatic enrollment program, you must notify your employees 30 to 45 days before you start the automatic enrollments and provide them with the information they will need to decide about their participation in the program.
We will be happy to work with you on designing and implementing an automatic enrollment program. Please contact any of the members of our employee benefits group for further information.