Since the Pension Protection Act of 2006 (PPA), Automatic Enrollment features in 401(k) and 403(b) plans have increased in popularity for large and small employers alike. PPA added fiduciary protection for Plan Sponsors, as well as safeguards for employees with requirements for advanced notices and default investments. But what exactly is an Automatic Enrollment feature? Is it appropriate for your plan design? First, let’s look at the requirements, then we’ll look at the pros and cons. With the right knowledge and information, you can determine if the Automatic Enrollment feature is right for you.
Educating Participants and Auto-Enrollment Options
The basic tenet of an Automatic Enrollment feature is this; Employees do not participant in the 401(k) plan mainly because of apathy and lack of education. They don’t know how much to contribute, and they don’t know where to invest their funds. An Automatic Enrollment feature takes that decision away from the employee; the employee is automatically enrolled in the 401(k) or 403(b) plan at a default level and their contributions are invested in a default investment fund unless the employee proactively says no.
There are three types of automatic options to consider: Automatic Contribution Arrangement (ACA), Eligible Automatic Contribution Arrangement (EACA), and Qualified Automatic Contribution Arrangement (QACA).
Here’s a quick overview of each:
ACA – The most flexible design, where there is no minimum contribution rate or required auto-escalation. There is also no required employer contribution. This design can be added to a plan at any time.
EACA – This design is like an ACA where there is no minimum contribution rate or required auto-escalation. There is also no required employer contribution. However, an EACA must be in place as of the first day of a Plan year. Also, employees may have up to 90 days to request to receive the return of their employee deferrals, without incurring the tax penalty.
QACA – The least flexible design, where there is a minimum contribution rate, the employer must provide a specific matching contribution, and participants must be fully vested in this match within two years of service. The QACA generally must be in place the entire year. If done correctly, this design will automatically satisfy certain non-discrimination testing. Also, employees may have up to 90 days to request to receive the return of their employee deferrals, without incurring the tax penalty.
Benefits and Drawbacks of Auto-Enrollment
The automatic enrollment feature isn’t a one size fits all and it isn’t the best choice for all companies and organizations, so look at these pros and cons before moving forward.
Benefits of auto-enrollment:
- Employees will be more likely to participate, and contributions will increase – This can help when it is hard to get employees to take part in the enrollment process.
- Employers may provide an automatic escalation feature where employees increase their contribution rate each year.
- Employees will defer paying income tax on their contributions.
- Employees are more likely to meet their retirement goals by participating immediately when they become eligible, rather than potentially waiting until later in their career.
- Auto-enrollment may help the nondiscrimination testing results, while the QACA plan will exempt a plan from certain nondiscrimination testing requirements.
Possible drawbacks of auto-enrollment:
- Setting the auto-enrollment contribution rate lower than a participant would have elected may negatively impact employee retirement savings goals, while setting it too high may cause employees to fully opt-out of the plan, negatively impacting both employee savings and overall participation.
- Employees may become disengaged and wrongly believe their needed retirement savings will be taken care of with auto-enrollment. The defaulted investment option may not be appropriate for the employee based on their specific situation. As Plan Sponsors, companies should continue to provide retirement education programs to their employees through their plan’s investment advisor to address this potential pitfall.
- There may be some added administrative time to incorporate and explain the automatic enrollment feature to employees, including the notice requirements for both the default or increasing deferral rate and the default investment option chosen by the employer.
- Employer matching contributions may increase with increased employee participation.
- Payroll integration is a must! Missing the first deduction for a newly eligible employee or missing the automatic increase deadline for a plan offering auto-increase features, can result in penalties to the employer, and a required contribution equal to 25% of the missed deferral plus the full match that should have been contributed.
- Small balances – since newly eligible participants are default enrolled, their initial account balances may reduce the average account balance of the plan overall. Some investment platforms may charge higher fees for plans with lower average account balances, so make sure to check with yours.
Still not sure if auto-enrollment is right for your organization?
While there is no blanket answer, we can help you understand how implementing an auto-enrollment feature might affect your company or organization – Contact us today!