401(k) Automatic Enrollment: The Easiest Way to Help Employees Save
If you’ve ever wondered if 401(k) automatic enrollment might be right for your employees, read on for answers to the most frequently asked questions.
“Maybe when I turn 30.” “Maybe when I get a bonus.” “Maybe when I pay off my student loan.” “Maybe when my horoscope tells me it’s time to invest.” When it comes to enrolling in their 401(k) plan, employees often say “maybe later.”
But the fact of the matter is the best time to save for retirement is right now because time (and the power of compounding) is on their side. That’s where 401(k) automatic enrollment comes in. If you’ve ever wondered if it might be right for your employees, read on for answers to the most frequently asked questions.
What is 401(k) automatic enrollment?
Automatic enrollment (otherwise known as auto-enrollment) allows employers to automatically deduct elective deferrals from employees’ wages unless they elect not to contribute. Simply put, it means your employees don’t have to lift a finger to start saving for retirement.
How does automatic enrollment work?
Typically, employees must go online, make a phone call, or submit paperwork to enroll in their retirement plan. It takes effort, and employees who are on the fence about enrolling might not take the time to do it. Before they know it, years have passed, and they’ve missed out on valuable time that they will never get back. However, you can automatically enroll employees and do all the work for them.
If you decide to add an automatic enrollment feature to your 401(k) plan, you must notify your employees at least 30 days in advance. After you do, they can decide to:
- Opt out—Employees can “opt out” of 401(k) plan participation in advance (at Betterment, employees can do this easily online).
- Change the contribution amount or investments—Instead of just rolling with the default automatic enrollment elections, employees can elect their own contribution rate and investment funds.
- Do nothing—Employees don’t have to take any action. If they do nothing, once the “opt-out” timeframe has elapsed, they will automatically begin deferring a certain percentage of their pay to their employer’s plan. =
As you can imagine, many employees do nothing, and as a result, start saving for their future (which is fantastic!). In fact, according to research by The Pew Charitable Trusts, automatic enrollment 401(k) plans have participation rates greater than 90%! That’s in stark contrast to the roughly 50% participation rate for plans in which employees must actively opt in.
What are the different kinds of automatic enrollment?
There are actually three different kinds of automatic enrollment arrangements:
- Basic Automatic Contribution Arrangement (ACA) When employees become eligible to participate in the 401(k) plan, they will be automatically enrolled at preset contribution rates. Prior to being automatically enrolled, employees have the opportunity to opt out or change their contribution rates.
- Eligible Automatic Contribution Arrangement (EACA) is similar to ACA, but the main difference is that employees may request a refund of their deferrals within the first 90 days.
- Qualified Automatic Contribution Arrangement (QACA) has basic automatic enrollment features. However, it also requires both an annual employer contribution and an increase in the employee contribution rate for each year the employee participates. For this reason, a QACA 401(k) plan is exempt from most annual compliance testing.
If at first you don’t succeed, try again
If employees opt out of 401(k) participation, that’s it, right? Well, not quite. According to the Plan Sponsor Council of America, in 2018, nearly 8% of plans annually re-enrolled employees who had previously opted out (that’s up from 4% that did so in 2013).
What are the most common automatic enrollment elections?
You have the freedom to select the percentage of employees’ compensation that is automatically contributed to the 401(k) plan. A 3% default contribution rate is still the most popular; however, more employers are electing higher default rates. That’s because research shows that opt-out rates don’t appreciably change even if the default rate is increased. And because many financial experts recommend a savings rate of at least 10%, using a higher automatic enrollment default rate gets employees even more of a head start.
In addition to selecting the contribution percentage, you’re also responsible for selecting the default investments for employees’ deferrals. According to the IRS, you can help limit your investment liability by using default investments that meet certain criteria for transferability and safety, such as well-diversified funds or portfolios.
What’s good (and not so good) about automatic enrollment?
The best thing about automatic enrollment is that it helps employees—of all ages and salary levels—start saving for retirement. It makes saving for the future painless and productive (and offers significant tax advantages). Plus, an increased participation rate makes it easier for your plan to pass required compliance tests.
However, there are a couple downsides to consider. When a plan uses automatic enrollment, often the default rate is set low (say around 3%). For most employees, this low saving rate may not be enough to live comfortably in retirement. But because employees didn’t actively choose the rate, they may not be inclined to increase it on their own. Wondering how to combat retirement saving inertia? Betterment can help by offering your employees personalized retirement advice.
How can Betterment help?
As an experienced 401(k) plan provider, Betterment can help your employees save for their futures with compelling plan design features like automatic enrollment and personalized financial advice. In fact, we offer employees specific advice on contribution rates, investment options, and which accounts to use (including those they may hold elsewhere). That way, even if your employees are automatically enrolled in the plan, they’ll get the advice and encouragement they need to boost their contribution rate, select appropriate investments, and save for the retirement they envision.
Your employees deserve a better 401(k) plan.
The information provided is education only and is not investment or tax advice.