Roughly 60% of Americans have access to an employer-sponsored 401(k) plan, yet only about a third of that group is currently enrolled. That’s a staggeringly low participation rate, especially considering the 401(k) plan is widely considered the best retirement investment vehicle for most people. Widespread confusion and limited education on how 401(k) plans and investments work creates an environment where far too many people ignore enrollment opportunities.
If your 401(k) plan isn’t hitting the desired participation rate, auto-enrollment is a possible solution. As a program sponsor, you can adopt 401(k) auto-enrollment for every employee who meets your enrollment criteria. By consequence, this leads to much higher participation rates and can benefit employees who fail to enroll under a traditional enrollment scheme. Your timid employees may appreciate your efforts down the road, yet there are both pros and cons associated with automatically enrolling every employee into your plan.
What Is Auto-Enrollment?
401(k) auto-enrollment is exactly like it sounds. Employees who meet your plan’s eligibility criteria are automatically enrolled in the program as soon as they qualify. For example, if your plan requires an employee to be 21 years old and have worked with you for a minimum of 6 months, auto-enrollment would kick in once that employee meets both of those established criteria. Employees who do not wish to participate must opt out before auto-enrollment occurs.
By comparison, traditional 401(k) enrollment requires employees
to take action to enroll in your sponsored plan. Enrollment criteria can be the same under a traditional 401(k) enrollment scheme, but for myriad reasons—including debilitating fear about 401(k) programs—a large body of employees won’t put in the time to enroll.
Pros of 401(k) Auto Enrollment
The most obvious and immediate benefit to 401(k) auto-enrollment is a boost to your program participation rate.
Additionally, auto-enrollment helps you:
- Improve employee retirement situations (especially for younger employees)
- Offer more employees the benefit of retirement contribution matching
- Reduce enrollment friction for your HR department*
- Become better situated with IRS 401(k) ADP and ACP compliance tests
- Lower your business’ taxable income through increased plan contributions
It should take under a year before you and your employees start realizing most of these benefits to auto-enrollment. The big exception here is the potential negative impact on your HR department. While auto-enrollment will ideally lead to less paperwork and time investment for your employees, this may not be the case for every business. Businesses with low-wage workers and high turnover rates, for example, could end up paying hundreds or thousands of dollars per year in administrative fees and other account-related charges due to numerous abandoned accounts.
Cons of 401(k) Auto-Enrollment
Offering a 401(k) plan can help attract top talent and increase employee morale, especially if the process is simplified with auto-enrollment. But it won’t leave every employee with a sunny disposition, and it could cause you to spend more in administration costs for an increasing number of abandoned plans.
Employees may forget their auto-enrollment date
Most employees ignore the different lines on their paycheck, instead focusing on the take-home number they see either on their physical check or deposited into their bank account. That number is usually consistent across pay periods, at least until auto-enrollment kicks in. Once they’re auto-enrolled, your employees will see a lower amount based on the contribution percentage you’ve established with the program administrator.
The IRS requires that you notify employees 30-90 days before the plan year that they’ll be auto-enrolled, or on the day of hire for auto-enrollment that occurs immediately. We recommend more frequent notification, and in particular, notification much closer to the enrollment date. Those reminders might also need to be phased out, or at least, not be used as your primary reminder method. You’ll want to get everything in writing and into the format your employees are most likely to pay attention to, be it email, Slack messages, physical mail, or as many communication channels as possible.
Even then, some employees will miss the message or fail to understand the implications of what auto-enrollment means. Once they see their paycheck is lower, the angry emails to managers and HR could start flowing in. You can counteract this with more frequent communication and regular reminders leading up to each employee’s auto-enrollment date. Auto-enrollment communication can be automated, and your program administrator can help you establish the necessary flow of information that should help reduce potential push-back.
High turnover and low wages can lead to costly abandoned plans
Most 401(k) plans are not prohibitively expensive to sponsor for businesses of any size. Even for small businesses, yearly administrative costs can come in under $1,000 per year alongside per-participant fees that can range between $15 to $60 per year per participant (or more).
High employee turnover rates can complicate and increase your annual administrative costs. Any auto-enrolled employee can roll over their 401(k) plan to an IRA or move those funds to another company’s retirement account. Of course, that’s not an automated process; employees need to take deliberate and separate action to do that once they end employment with your company.
As identified, a large number of employees will take the path of least resistance. Until an employee takes action on that vested amount or that money is disbursed back to the employee, you’ll be stuck paying the administration fee. That likely means you’ll end up paying for far more abandoned 401(k) plans than you anticipated once you adopt auto-enrollment.
There are a few possible solutions to these issues:
- Create stricter auto-enrollment criteria (such as a longer employment period threshold)
- Use a force-out or mandatory cash-out provision
- Establish an automatic rollover provision
- Reduce employee turnover rates
Steps to Take Before Adopting 401(k) Auto-Enrollment
Auto-enrollment can help you and your employees get the most out of a sponsored 401(k) retirement plan. But it may not be the best for your company, or you may need to adjust some of the features and structure of your plan prior to establishing auto-enrollment. Before you switch to auto-enrollment, make sure you:
- Speak to your internal team responsible for plan management. They’ll have a fairly good idea about whether your employees actually want or even need auto-enrollment. If your voluntary enrollment numbers are already high, for example, you may not need to institute auto-enrollment at all. Alternatively, if you have high employee turnover rates, your HR team may have some suggestions for boosting retainment before you begin to add more people to the plan.
- Speak to your employees. Remember the path of least resistance discussion we had earlier? Many of your employees may love the idea of auto-enrollment because it takes the weight of decision-making off their shoulders. Alternatively, you may have employees who are focused on the here-and-now cash flow and outright reject having money come from their paycheck. You can alleviate these concerns by helping educate employees on how 401(k) plans work and the benefits of them, but you don’t want to spring auto-enrollment on employees who are predisposed to be hostile to the idea.
- Speak to your plan administrator. Auto-enrollment may come with some additional administrative costs and may require additional changes to your plan’s structure. Your program administrator should be able to walk you through the process and provide you with the resources you need to relay information to your employees.
The magic number of a legally-required 401(k) audit is 120 eligible participants. Changing to auto-enrollment may push you past that limit for the first time. We specialize in 401(k) audits and can help you keep your sponsored plan in proper working order. Contact our office at (260) 497-9761 to schedule an appointment to see how we can assist you.