401(k) Plan Automatic Enrollment: A Winning Formula

Although the number is slowly shrinking, many 401(k) plan sponsors remain reluctant to institute automatic enrollment and automatic deferral increase features. However, the fact still remains, plans with these features generally have higher participation rates and account balances.

Looking at the Numbers

According to Vanguard, 34% of the plans that it provides recordkeeping services for automatically enroll new, eligible employees — up 10% from five years ago. Generally, automatic enrollment increases participation rates. Based on Vanguard’s data, the average participation rate for automatic enrolled plans is 82% vs. 65% for voluntary plans. Participation rate variances are even more dramatic when examined by employee demographics. For example, the average participation rate of employees earning less than $30,000 at auto-enroll companies is 78%, but just 34% in voluntary enrolled plans.

Employers’ willingness to automatically enroll employees correlates with their size. Only 25% of employers with less than 1,000 employees auto-enroll, whereas at least 55% of employers with 1,000 or more employees use this feature. Why the disparity? One possibility is that smaller employers harbour concerns about increased plan expenses if they auto-enroll employees and provide some level of matching contribution.

Similarly, the participation rate for workers below the age of 25 is 68% at auto-enroll companies and a meager 29% elsewhere, according to Vanguard. Boosting participation rates among young employees allows them to maximize the benefit of compounding savings accumulation rates. The compounding advantage is much more dramatic for plans that also automatically increase default contribution rates by 1% each year.

Playing to Win

From an employer perspective, higher participation rates through both automatic enrollment and automatic deferral increase features are beneficial for several reasons. First, employees who are on track to funding their retirement are more likely to retire, rather than stay in jobs to pay for their basic living expenses. A dynamic workforce tends to be more productive than one which is stagnant. Employees who take advantage of a 401(k) plan, particularly employer-matching contributions, appreciate the value of the benefit and tend to feel more highly compensated.

In addition, with more participation and dollars in the plan, the more leverage employers have to negotiate with service providers. To establish an automatic enrollment 401(k) plan, employers should first decide whether to set up the plan themselves, or to consult a professional to help establish and maintain the plan.

Employers would need to adopt a written plan document and arrange a trust for the plan’s assets. They should make sure they have a recordkeeping system that can manage automatic enrollment and automatic deferral increase provisions. Finally, they will need to provide plan information to employees who are eligible to participate. Employees must receive an initial notice before automatic enrollment in the plan, and receive a similar notice each subsequent year.

It’s a Win for Everyone

Automatic enrollment, coupled with automatic deferral increases, isn’t only good for participants, it’s also good for employers. Higher participation in 401(k)s by rank-and-file employees allows for higher limits for key employee contributions. Keeping key employees around with the incentive of higher contribution limits may decrease turnover. Automatic enrollment can be a win for everyone.

Join Our Newsletter

Sign up to receive exclusive newsletters with the latest information affecting you and your organization.

Posted in

SHARE THIS POST