After concluding my second quarter client meetings, I was surprised by the number of clients who wanted to discuss how their employees would feel about being enrolled in their plan automatically. Many of these conversations emanate from the concern that participants will react negatively to being automatically enrolled; that perhaps this plan design is to paternal. But before I express my thoughts on the “pros” and “cons” of automatic enrollment for participants, 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.
Pros of auto-enrollment:
- Employees are more likely to participate. Unquestionably, inertia is the greatest obstacle to getting people to start saving for retirement. According to Vanguard, nationwide, plans that have participants voluntarily enroll have a participation rate of 57%, but plans with automatic enrollment have a 92% participation rate.[2]
- Participants will stay enrolled. While this is both a pro and a con, I’ll list it here as a pro. In my experience and corroborated by Vanguard’s Automatic Enrollment: The Power of The Default,[3] 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%).[4]
- Participants will save. If participants are enrolled at a rate that combined with the employer contributions is near an appropriate savings rate, this may be a virtuous plan design. According to American Century Investments, 5th Annual National Survey of Defined Contribution Plan Participants, 75% of employees surveyed would say yes to being automatically enrolled at 6%.[5]
- Participant don’t mind auto increases. A participant’s default deferral rate can be auto-escalated each year. If you do start at a low rate, consider auto-escalating them by 1% each year. Participants tend to not miss a 1% increase in savings rate and before the know it, they are saving at a reasonable rate. According to American Century, 80% would say yes to annual automatic increases in their savings rate. [6]
- The bite of savings is minimized because employees will not be taxed on their traditional contributions.
- Participants enrolled in a Qualified Default Investment (QDIA) such as a target-date fund, are invested in what is considered to be an appropriately diversified investment vehicle, rather than left to their own investment decision.
- Participants with adequate savings rates are less distracted at work and can retire at a reasonable age. According to the Center for Financial Services Innovation, “Nearly one in three employees report that issues with personal finances have been a distraction at work.”[7] Given the auto-pilot nature of automatic enrollment and the use of a QDIA, your participants could leave more worries at the door.
- And aside from the above, auto-enrollment may help the annual nondiscrimination testing results.
Cons of auto-enrollment:
- Participants can get locked in, due to inertia, at a lower savings rate than is prudent. As mentioned above, we see participants keep their deferral rate that was set at enrollment. Therefore, if you enroll them at a low deferral rate, they are likely to stay enrolled at that lower rate and may not save enough for retirement.
- Employees can be disengaged and wrongly believe their needed retirement savings will be taken care of with auto-enrollment. Sans auto-increases, employers may want to consider providing retirement planning or education programs to their employees to address this misconception.
- Once considered a “con” because participants felt the employer was forcing them to do something, auto-enrollment is now over a decade old and participants are more comfortable with the idea because they have heard about it from other sources. And, as noted above, 75% of employees surveyed, would say yes to being automatically enrolled at 6%.[8]
- Participants who do choose to cancel their automatic enrollment will, depending on the type of automatic enrollment and how long they have been enrolled and the availability of loans and hardship distributions, not have ready access to their money until they have a distributive event.
Given that we know participants don’t truly start saving for retirement until later in life and that automatic enrollment is gaining wider and wider adoption and acceptance, perhaps implementing automatic enrollment would truly be appreciated by your employees and be in their best interest.
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] How America Saves 2018, Vanguard 2017 Defined Contribution Plan Data
[3] Automatic Enrollment: The Power of The Default, February 2018
[4] Pensions & Investments: Default deferral rates for DC plans get a nudge up
[5] American Century Investments, 5th Annual National Survey of Defined Contribution Plan Participants
[6] American Century Investments, 5th Annual National Survey of Defined Contribution Plan Participants
[7] Center for Financial Services Innovation Employee Financial Health: How Companies Can Invest in Workplace Wellness
[8] American Century Investments, 5th Annual National Survey of Defined Contribution Plan Participants
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