The Pros and Cons of Automatic Enrollment in Retirement Plans

Automatic enrollment in retirement plans has become increasingly popular in recent years, with many employers choosing to implement it to encourage their employees to save for retirement. The movement toward this approach has been so significant that the recently passed SECURE 2.0 Act requires new plans to automatically enroll and escalate savings rates. While automatic enrollment offers several key advantages, it has risks and limitations. In this post, we will explore the pros and cons of automatic enrollment and provide guidance on implementing it effectively.

The Pros of Automatic Enrollment

The benefits of automatic enrollment extend beyond the critical difference in participation rates. Automatic enrollment offers several additional benefits, including:

  • Higher Savings Rates: Automatic enrollment, developed thoughtfully, can lead to higher savings rates. By setting good default savings rates and incorporating automatic increase programs, employers can significantly increase savings rates beyond those achieved by most opt-in plans.
  • Reduced Decision-Making Burden: Automatic enrollment removes the burden of making investment decisions from employees who may not have the time or knowledge to make informed decisions.
  • Increased Diversification: Finally, automatic enrollment can lead to increased diversification among employees. When employees are automatically enrolled, they are more likely to invest in a diversified portfolio rather than putting all their money in one investment option.

The Cons of Automatic Enrollment

Despite its many benefits, automatic enrollment can have drawbacks, which should be carefully thought through prior to implementation. These risks include:

  • Higher Costs: Automatic enrollment is more expensive for most employers. More people participating means more match dollars paid. Understanding budget constraints on employer contributions and goals for allocation is critical before proceeding toward a change in design.
  • Reduced Engagement: Automatic enrollment may lead to reduced engagement among employees. For employers who articulate engagement as a goal, most automatic enrollment plans are outcome-oriented – designed to impact participant outcomes, rather than attempting to modify engagement or interest in the topic.
  • Increased Administrative Burdens – Automatic enrollment requires changes to the enrollment system for employers. For some employers, automatically enrolling each participant may create administrative challenges if they do not have strong payroll system in place and do not utilize data exchange tools with their recordkeeping vendor.

Factors to Consider

A well-designed automatic enrollment feature can materially improve the financial well-being of your employees. So, what are the eight questions sponsors should ask before implementing an automatic enrollment feature to their defined contribution plan?

  1. What will the cost of a change in plan design be? Plan sponsors should evaluate the costs associated with implementing and administering automatic enrollment, including additional administrative fees, recordkeeping costs, and communication costs. The highest among those costs is likely increased match cost.
  2. What are our organizational demographics? Plan sponsors should consider their employees' age, income, and other demographic characteristics to determine when and at what percentage of pay automatic enrollment should be engaged.
  3. What is our current participation rate? Plan sponsors should evaluate the participation rates in their plan and whether automatic enrollment can help increase participation rates. Well-designed automatic enrollment plans generally see 90%+ of new hires participating. How does this compare to current participant behavior?
  4. How much do employees contribute today? A risk of plans with automatic enrollment is seeing more people saving, but at lower rates. Targeting savings rates that are at or above current savings rates helps offset the concern of less engaged participants contributing less to their retirement plan as does pairing automatic enrollment with automatic escalation.
  5. Are there plan design impediments to adopting automatic enrollment? Plans with a significant delay between the hire date and retirement plan eligibility more frequently struggle with automatic enrollment as employees become accustomed to a net paycheck prior to eligibility and are more likely to opt out when they experience a reduction in net compensation. Additionally, some state plans exempt from the Employee Retirement Income Security Act (ERISA) may not be permitted to adopt automatic enrollment if state laws prohibit wage withholding without an employee’s consent.
  6. How do we communicate the plan design to new hires? Plan sponsors should evaluate whether they have the resources and infrastructure to effectively communicate the automatic enrollment feature to their employees in a manner that complies with the requirements of ERISA. In some cases, these can be outsourced to the plan’s recordkeeper, but in other instances, they may require direct work from the sponsor.
  7. How will automatic enrollment impact annual testing requirements? Plan sponsors should evaluate the compliance requirements associated with automatic enrollment, including nondiscrimination testing and other regulatory requirements. Certain designs of automatic enrollment plans may be exempted from some forms of compliance testing. Understanding where those safe harbors intersect with other decisions of automatic enrollment is an important step in defining a structure that works effectively.
  8. How will automatic enrollment change our fiduciary responsibilities? Operating plans in accordance with your plan document and applicable law is a requirement for any plan sponsor. When evaluating automatic enrollment, define where new requirements and disclosures emerge and determine whether the additional responsibilities can be executed well. For instance, plans with automatic enrollment will likely require new annual disclosures to participants who have been automatically enrolled in the plan.

Best Practices for Implementing Automatic Enrollment

If you decide to implement automatic enrollment in your retirement plan, it is important to follow three critical best practices, including:

Adequate Communication: Communication is key when implementing automatic enrollment. Employers must clearly communicate the benefits of automatic enrollment and how employees can opt-out if they choose to do so.

Proper Default Investment Options: Employers must choose appropriate default investment options that are diversified and suitable for their employees. The selection and monitoring of default investment options is an area of increased litigation and should be addressed with thoughtfulness and skill.

Regular Monitoring and Review: Finally, employers must regularly monitor and review their automatic enrollment feature to ensure that it is working effectively and meeting the needs of their employees. This monitoring should touch on utilization, communication, and efficacy to determine if any of the underlying assumptions have changed.

Automatic enrollment in retirement plans offers many advantages, including increased participation rates, higher savings rates, reduced decision-making burden, and increased diversification. However, there are also drawbacks, including higher costs, risks, and even potentially lower total savings rates.

Net/net automatic enrollment is one of the most impactful steps an employer can take in helping employees secure a successful retirement. In most cases, any emerging risks can be managed through thoughtful planning and design.

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.

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