The Highs and Lows of Auto-Enrolls

checkThere is a fascinating social science study that was conducted by Eric Johnson and Daniel Goldstein that studied the willingness of people across European countries to donate their organs after they pass away (stay with me since I know this seems to have nothing to do with your 401(k) plan). They compared Denmark and Sweden, Austria and Germany, the Netherlands and Belgium and France and the U.K.; the countries were paired based on their similarities in culture, religion, and norms. However, despite the likenesses there were significant discrepancies in their organ donation opt-in rates: Denmark’s opt-in rate was 4.25% while Sweden was at 85.9%, Germany was at 12% while Austria was at 99.98%, the Netherlands was at 27.5% while Belgium was at 98%, and finally the UK was at 17.17% while France was at 99.91%. So what could possibly explain the significant differences in these similar countries? As it turns out, it was a simple difference in the design of the organ donation opt-in process on the form at the D.M.V. In the countries where the form in set as “opt-in”, check a box if you would like to donate, people tended not to check the box and therefore do not become part of the program. The countries where the box on the form read “opt-out”, check if you do not want to participate, people do not check the box and are automatically enrolled in the program. The conclusion of the study was not that people do not care about whether or not their organs are donated postmortem, but rather how small changes in our environment, “opt-in” versus “opt-out” can shape our decisions.

Which brings us to the discussion of automatic enrollment in a 401(k) plan and the subsequent effects on your plan – the highs and the lows. While the concept of automatic enrollment, or negative election, has been in place since the mid-1990s, the Pension Protection Act of 2006 encouraged and therefore accelerated the use of automatic enrollment provisions within 401(k) plans by removing some of the regulatory requirements. Furthermore, the IRS eased some of the restrictiveness of correction methods for automatic enrollment in Rev. Proc. 2015 – 28 ( With the groundwork laid for the use of automatic enrollment, let’s examine the pros and cons to adding this plan design feature.

High – Increased Participation
The most obvious high of adding automatic enrollment to your 401(k) plan is an increase in participation. When making the decision to amend your plan to add the provision, there are two choices; make automatic enrollment effective for all eligible employees or just for those who become eligible after the provision is put in place. If you elect to enroll all eligible employees, there’s a better chance that you will see a dramatic impact in participation numbers. We work with a lumber company that opted to make the automatic enrollment provision effective for all eligible employees and their participation rate doubled virtually overnight. With greater participation, the plan may be more likely to pass annual compliance testing and will have an employee population that may be better prepared to retire.

Low – Stagnant Deferral Rates
The fear with adding automatic enrollment without auto-escalation, increasing deferral percentages on a set schedule until a certain level is reached, is that participants will get enrolled in the plan at the designated deferred percentage, typically 3%, and then never give another thought to increasing their deferral percentage. While 3% is certainly better than 0%, 3% will more than likely not get your participants to their retirement goals. In order to combat stagnant deferrals, a regular and meaningful education program should be put into place along with utilizing GAP analysis tools that can illustrate what your participant’s current deferral amount will equate to in retirement income.

High- Flexibility within the Automatic Enrollment Provisions
The number one reason that we hear as to why a company is hesitant to add an automatic enrollment provision is that they are afraid their employees will be frustrated that their money was contributed without their consent and now it is locked into a plan they don’t want to participate in. The easiest way to avoid this situation is by selecting the correct automatic enrollment arrangement. There are three types: basic automatic enrollment 401(k) plan, eligible automatic contributions arrangement (EACA) and qualified automatic contribution arrangement (QACA). The basic feature is what most employers understand automatic enrollment to be, a stated percentage of eligible employee’s wages will be automatically deducted from each paycheck unless the employee elects to not participate. The EACA allows automatically enrolled participants to withdraw their contributions with 30 to 90 days of the first contribution without penalty (standard tax rates apply); thereby solving the concern that participants may be unable to access their money.   Finally, the QACA plan design allows the plan to automatically pass certain annual compliance tests and must include features such as a fixed schedule of automatic employee contributions, employer contributions, a special vesting schedule, and specific notice requirements.

Low – Increased Plan Costs
There is a pretty good chance that as your plan adds participants and assets, the costs will rise in potentially a few ways. First, if your company offers a match, then the more participants there are contributing to the plan, the more the company will owe in company match. Second, depending on your contract with your 401(k) plan providers, more participants could mean higher cost if there is a per head fee and/or greater assets could lead to a higher dollar amount if the fees are based on plan assets. When your plan opts to add automatic enrollment, the plan should also consider renegotiating provider fees in order to make sure that the change in participation and assets will not negatively impact the appropriateness of the fees.

As with any plan provision, it is important that the plan committee closely examine all of the highs and lows of amending the 401(k) plan. Please let me know if I can be of any assistance in assessing whether adding automatic enrollment would be appropriate for you plan.

Jamie Kertis, AIF®, QKAjamie kertis headshot
Retirement Plan Specialist
Grinkmeyer Leonard Financial
1950 Stonegate Drive / Suite 275 /Birmingham, AL 35242
Office: 205.970.9088 / Toll-Free: 866.695.5162

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