Is Automatic Enrollment A Good Fit For Your Retirement Plan?

What Is Automatic Enrollment?

First, we need to identify the most popular form of election - the salary reduction agreement. In this, the employee agrees to reduce compensation in exchange for the deferral. The salary reduction agreement may apply to current salary, to a salary increase, or to a bonus, commission, or other form of compensation for services, based on the definition of compensation in the plan documents.

The salary reduction agreement (or deferral election) puts the onus on the employee to make the first move which might be more difficult than expected. Including an Automatic Enrollment provision in your plan can help increase participation rates. Under this structure, the employee's compensation is automatically reduced by a percentage specified in the plan (e.g., 6%) unless the employee makes a contrary election (higher, lower, or 0%).

Auto-Escalation 

Automatic enrollment may be subject to automatic annual increases up to a cap amount specified in the plan document. We call this auto-escalation, and the cap is currently 15% but can be lowered. Depending upon how the plan is set up, the increases generally are applied as of the first day of each plan year in whole number increments. For example, if participant A is enrolled automatically at 6% the subsequent year will be 7%, then 8% the year after, etc. until the limit cap is met. This assumes the participant does not adjust their election in the first or any subsequent year.

Practical Examples and Framing

In 2020, according to the Bureau of Labor Statistics (BLS), the national average salary was $56,310 and the median was $41,950. Below we use the average salary to illustrate the impact of higher pre-tax savings on not only net semi-monthly pay but total retirement account value 30 years later. 

Framing sometimes goes out the window when we talk about retirement planning. Sometimes it may be better to pose questions about deferral elections into dollars rather than percentages of compensation. Whichever method your company chooses to use with participants, it's a good idea to remember that sometimes it's better to frame questions with comparative scenarios.

For example: What if we were to tell you that you could save $300 per month but it would only cost you $194, would you do it? And, what if we were to say that over 30 years that $300 per month savings would equate to approximately $451,000? Would you start saving? Or, would you increase your savings to $500 a month, costing you only $324 after taxes and leaving you with a balance of $751,000?

Select Examples

Types of Automatic Enrollment

There are three different types of automatic enrollment:

(1) Basic automatic enrollment (Automatic Contribution Arrangement or ACA):

• Employees are automatically enrolled in the plan unless they elect otherwise
• Plan document specifies the percentage of wages that will be automatically deducted
• Employees can elect not to contribute or to contribute a different percentage of pay

(2) Eligible automatic contribution arrangement (EACA):

• Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice
• May allow employees to withdraw automatic contributions, including earnings, within 90 days of the date of the first automatic contribution

(3) Qualified automatic contribution arrangement (QACA):

• Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice
• Meets additional “safe harbor” provisions that exempt the plan from annual actual deferral percentage (ADP) and actual contribution percentage (ACP) non-discrimination testing requirements
• Default deferral percentage starts at 3% and gradually increases to 6% with each year that an employee participates. The default percentage cannot exceed 10%.
• Required employer contributions. Pick either:
  • matching contribution: 100% match for elective deferrals that do not exceed 1% of compensation, plus 50% match for elective deferrals between 1% and 6% of compensation; or
  • non-elective contribution: 3% of compensation for all participants, including those who choose not to make any elective deferrals.
• Employees must be 100% vested in the employer’s matching or non-elective contributions after no more than 2 years of service
• Plan may not distribute any of the required employer contributions due to an employee’s financial hardship

Some types of automatic enrollment are a little more complicated than others. This is why Uniglobal provides the opportunity to design your retirement plan during implementation to help you decide what option, if any, may be right for your retirement plan. 

Automatic Enrollment In Practice

You've learned about what automatic enrollment is and the ins and outs of the different types of automatic enrollment. What does this look like in practice? 

If you are working with a recordkeeper to hold the assets of your retirement plan, many can automatically provide enrollment and education materials directly to your employees as they approach their eligibility date. This will allow them to educate themselves on what deferral percentage they can expect to be withheld from their wages and how to opt-out if they so choose. If your recordkeeper or asset provider does not track automatic enrollment eligibility, the responsibility of providing enrollment and education materials to new participants will fall to your company's human resources department. 

With an automatic enrollment provision, it is imperative to track approaching eligibility dates and enrollment status for your employees to ensure deferral amounts are withheld from pay beginning on the correct payroll period and to avoid a missed deferral opportunity.

The additional payroll administration steps that come along with an automatic enrollment feature should be weighed when considering the benefit of including or adding automatic enrollment to your retirement plan.

Final Thoughts

Automatic Enrollment with Auto-Escalation results in larger future savings.

The bigger the payoff is in the future, the more likely we will select a higher deferral election amount today. Knowing this, plan sponsors (employers) can confidently aim for higher automatic enrollment percentages right out of the gate.

Assumptions: Compound interest rate of 8% over 30 years, $1,000 initial contribution, monthly contributions. Compensation net after-tax take-home calculations based on a single tax filer subject to Federal income tax and VA State income tax.

Disclaimer: This post is intended for educational purposes only and does not constitute, nor should be interpreted as, in any way, legal, investment, or tax advice.