Automatic enrollment - solving a major 401(k) problem

Many benefit plan sponsors face the frustrating problem of lowemployee 401(k) plan participation. In addition to the concern thatemployees don’t have enough money to live on during retirement, failedactual deferral percentage tests prevent highly compensated employeesfrom contributing as much as they would like to the 401(k) plan. Someplans can solve this problem with a fully vested safe harbor employercontribution, but this approach is far too costly for many employers,especially larger companies.

If your company has done everything possible toincrease 401(k) plan participation — with solid communications, anattractive matching contribution and great investment options — youcould implement another possible solution: Automatic enrollment. Unlessthey opt-out, this option means you wouldn’t have to wait for theemployee to elect to enroll in the plan.

The concept of automatic enrollment
Automatic enrollment changes the decision from “Should I participate?”to “Should I elect out of the plan?” The basic assumption is that it’smuch easier to keep employees in the plan, than it is to get them tosign up for it.

Higher401(k) plan participation increases the odds that employees willaccumulate enough retirement funds so they can actually retire. And bymaking the decisions for them, employees’ fears of making poordecisions about how much to contribute and where to invest arelessened. The IRS has supported the use of automatic enrollment since1998 and allows its use in preapproved prototype plan documents.

Advantages of automatic enrollment include:

Participants who might not save are saving for retirement
Employer automates the enrollment process
Improved nondiscrimination test results by eliminating many participants
A large portion of automatically enrolled employees stay in the plan, as evidence indicates
Employers are better able to meet the ultimate goal of creating retirement benefits for employees

Disadvantages include:

Some employees unable to save for retirement due
to personal situations (i.e., child support and wage garnishments)
Participants false sense of security that they’re saving the right amount with the default deferral rate
Employerresponsibility for investing the participant’s money unless or untilthe employee makes his own investment elections
Employees may opt out after a few deferral periods, leaving a small balance that the plan cannot distribute
More small accounts from short-term employees that employers will have to cash out
Employersconcern about the application of state law restrictions on wagewithholdings without an employee’s written consent (special concern formultistate employers)

Note:The Department of Labor has issued advisory opinions for New York andPuerto Rico affirming that the Employee Retirement Income Security Act(ERISA) permits auto-enrollment and that ERISA preempts state wagelaws. Pending legislation in Congress would affirm the federalgovernment’s view that ERISA preempts state law in this regard.

DebbieTurner is a director with RSM McGladrey Retirement Resources. For moreinformation, contact her at debbie.turner@rsmi.com.

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