On July 17, I wrote the blog, Automatic Enrollment: Participant Perspective. In this post, I want to walk you through the employer’s perspective. Let’s first define what automatic enrollment means.
According to the Internal Revenue Service, (IRS), “Automatic enrollment allows an employer to automatically deduct elective deferrals from an employee’s wages unless the employee makes an election not to contribute or to contribute a different amount.”[1] I’ve italicized and bolded employee’s wages because I’ve heard numerous people mistake enrolling a participant for their annual employer contribution, rather for salary deferrals. Automatic enrollment specifically refers to a participant’s salary deferrals.
Automatic enrollment and automatic deferral escalation continue to get a lot of attention in the press. The main reason many of my clients consider automatic enrollment is to help more employees accumulate greater retirement savings by removing the inertia that employees succumb to, rather than taking the proactive step of enrolling.
On the other hand, it can become expensive and problematic for some plan sponsors. Why? More people enrolled may mean an increase in employer funding costs. Then there are the increased administrative efforts, and the reporting required to have the auto feature(s) work properly. With automatic enrollment implementation, coordination between all service providers is critical.
Pros of auto-enrollment:
- More financially secure employees. Automatic enrollment in an employer-sponsored retirement plan enables a cost-effective and functional saving plan that may not otherwise be available for employees. This helps participants save for retirement which creates a healthier and happier relationship with the employees as well as enable older participants to retire timely, which could offer cost savings benefits.
- Nondiscrimination testing help. Automatically enrolling non-highly compensated employees will help with the nondiscrimination testing, potentially allowing highly compensated employees to save more of their own money or receive and keep more of the employer contribution while reducing any refunds or corrective contributions.
Cons of auto-enrollment:
- Increased cost to the employer. Given the improvements in participation resulting from automatic enrollment, employers who offer a matching contribution may increase the cost to the employer due to the increased employee participation.
- Increased administrative efforts. Having more participants enrolled increases the number of participants that must receive their annual notices and disclosures such as eligibility notice and the Qualified Default Investment Alternatives notice. This may not be an issue if your recordkeeper handles fulfillment, but if your staff is responsible for fulfillment, this can increase their burden. Further, if you have a force-out provision (also known as a small sum distribution provision) in your plan, you’ll face the burden of trying to track down participants with small sums that were automatically enrolled to properly distribute the proceeds of their account when they leave employment.
- Payroll pains. Before you implement automatic enrollment, check to see that your payroll vendor can send the necessary data to your recordkeeper to administer the enrollment of participants and ensure your recordkeeper can fulfill the notice requirements. If either party cannot automate the data transfer and notice delivery, this burdon will fall back on you, the employer.
- Administrative errors. If a participant is not enrolled properly, or timely, the employer may have to make a qualified non-elective contribution for the employee that compensates for the missed deferral opportunity. Employers need to ensure that payroll is properly tracking new hires, their eligibility, and then enrolling in a timely manner. A secondary concern is rehires. You need to make sure you have a way to track newly rehired employees’ eligibility. This rehire issues seems to be more of a challenge than originally considered and can create recurring administrative failures.
- Low savings rates. Participants may stay enrolled at the default enrollment rate and not save enough for their retirement. In my experience and corroborated by Vanguard’s Automatic Enrollment[2]: The Power of The Default, participants will stay enrolled at the default enrollment rate. According to this study, only 6% of participants lowered their default savings rate within the first year, while 34% of automatically enrolled participants increased their savings rate. Further, according to Wells Fargo Institutional Trust & Retirement, opt-out rates for a 3% deferral rate (11.3%) are almost identical to those rates at 6%(11.4%).[3] So, be thoughtful about what default deferral rate you choose and consider automatic increases to assist your participants in saving enough for and retiring at a reasonable age.
- Plan pricing. Increasing the number of small account balances will lower the average account balance which could hurt plan-level pricing. Given that the retirement industry prices services on an average account balance, this is something worthy of consideration.
Automatic programs create inertia for savings without the intimidation or decisions required to get started. In this respect, auto-enrollment can be a tremendous success. Starting late or investing too little can lead to significant shortfalls and challenged employees. According to PricewaterhouseCoopers LLP, nearly one in three employees report that issues with personal finances have been a distraction at work.[4] Net of the potential challenges with administering automatic enrollment, the positive attributes of automatic enrollment do seem to make automatic enrollment an appealing plan design.
For a discussion of the types of automatic enrollment, click here to be directed to the IRS website.
Notes:
[1] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-automatic-enrollment
[2] Automatic Enrollment: The Power of The Default, February 2018
[3] Pensions & Investments: Default deferral rates for DC plans get a nudge up
[4] “Employee Financial Wellness Survey: 2017 Results,” PwC, April 2017
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.
Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.