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If your client is experiencing low plan participation and failed ADP tests, automatic enrollment may be the solution.
Many plan sponsors face the frustrating problem of low employee participation in their 401(k) plans. In addition to concern for employees not having enough money to live on during retirement, failed Actual Deferral Percentage tests (ADP) prevent highly compensated employees from contributing as much to the 401(k) plan as they would like.
Some plans can solve this problem with a fully vested safe harbor employer contribution to the plan, but this approach is far too costly for many employers, especially larger companies. If your clients have done everything possible to increase plan participation with good employee communications, an attractive matching contribution, and great investment options, they can implement another possible solution: automatically enrolling employees into the 401(k) plan (unless they opt-out), instead of waiting for the employee to elect to enroll in the plan.
The Concept of Automatic Enrollment
Automatic enrollment changes the decision from “should I participate?” to “should I elect out of the plan?” The basic assumption is that it is much easier to keep employees in the plan than it is to get them in the plan.
Higher participation in the 401(k) plan increases the odds that employees will accumulate enough retirement funds so they can actually retire. And by making the decisions for them, it overcomes employees’ fear of making a poor decision in how much to contribute and where to invest. The IRS has supported the use of automatic enrollment since 1998, and allows its use in pre-approved prototype plan documents.
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What are the advantages?
- Participants who might not otherwise save are actually saving for retirement.
- The employer automates the enrollment process.
- The plan has improved nondiscrimination test results by reducing the number of non-contributing employees. Evidence indicates a large portion of automatically enrolled employees stay in the plan.
- Employers are better able to meet the ultimate goal of creating retirement benefits for employees.
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What about the disadvantages?
- Employees may opt out after a few deferral periods, leaving a small balance that the plan cannot distribute until the individual terminates employment.
- There will be more small accounts from short-term employees that employers will have to cash out.
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Default Investment Options for Automatic Enrollment Plans
The employer must select a prudent default investment for participants who are automatically enrolled in the plan, to be used until or unless the employee makes a personal investment selection. The Pension Protection Act of 2006 effectively created a fiduciary safe harbor for the investments of automatically enrolled participants who choose not to select their own investment options. The Department of Labor has issued proposed regulations defining default investment options as the following:
- Life-cycle or targeted-retirement date fund.
- Balanced fund.
- Managed account.
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Automatic Increases in Deferral Amounts
The employer must select a default salary deferral amount for an automatic enrollment plan. If the default deferral amount is too high, more employees may opt out. If the default deferral amount is too low, employees will not be saving sufficient amounts for retirement.
To balance these concerns, the employer may set the default deferral amount at a lower level (3 percent of pay for example), but then automatically increase the deferral percent each year until it reaches a higher level (6 percent to 10 percent of pay, or even higher) that will produce a meaningful amount of retirement savings for employees.
Employees may opt out of the annual increases at any time, but studies show that most employees find this to be a comfortable way to reach a higher retirement savings target.
Visit Symetra’s Retirement Programs page to learn more, or contact our Sales Center at invest@symetra.com or 1-800-706-0700. This article was submitted by Symetra partner McGladrey Retirement Resources, which comprises RSM McGladrey Business Solutions Inc. and Birchtree Financial Services Inc.
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