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401(k) Plan Automatic Enrollment: A Winning Formula

Although the number is slowly shrinking, many 401(k) plan sponsors remain reluctant to institute auto-enrollment and auto-deferral increase features. However, the fact is inescapable: Plans with these features generally have higher participation rates and account balances.

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A look at the numbers

According to Vanguard, as of year-end 2016, about 15% of the plans that it provides recordkeeping services for that permit employee-elective deferrals automatically enroll new, eligible employees. Generally, auto-enrollment increases participation and deferral rates. Participation rate variances are particularly dramatic when examined by employee demographics. For example, the overall participation rate of employees in 2016 for auto-enroll companies is 82%, but just 57% in voluntary enrolled plans.

The participation rate for employees earning less than $30,000 per year is double for plans with automatic enrollment. For those earning less than $30,000 per year the participation rate is 72% in those plans with automatic enrollment while only 33% without.

Similarly, the participation rate for young (below age 25) workers is 73% at auto-enroll companies and a meager 26% elsewhere, according to Vanguard. Boosting participation rates among young employees allows them to maximize the benefit of compounding savings accumulation rates. The compounding advantage is even more dramatic for plans that also automatically increase default contribution rates by 1% each year.

Play to win

From an employer perspective, higher participation rates through both auto-enrollment and auto-deferral-increase features are beneficial for several reasons. First, employees who are on track to funding their retirement are more likely to retire, rather than stay in jobs to pay for their basic living expenses. A dynamic workforce tends to be more productive than one that’s stagnant. Employees who take advantage of a 401(k) plan, particularly employer-matching contributions, appreciate the value of the benefit and tend to feel more highly compensated.

In addition, the greater the participation rate and dollars in the plan, the more leverage employers have to negotiate with service providers. To establish an auto-enrollment 401(k) plan, first decide whether to set up the plan yourself or to consult a professional to help establish and maintain the plan.

You’ll need to adopt a written plan document and arrange a trust for the plan’s assets. Make sure you have a recordkeeping and payroll system that can manage auto-enrollment and auto-deferral-increase provisions. Finally, you’ll need to provide plan information to employees eligible to participate. Employees must receive an initial notice before auto-enrollment in the plan and receive a similar notice each subsequent year.

It’s a win-win

Auto-enrollment, coupled with auto-deferral increases, isn’t good for only participants — it’s also good for employers. Higher participation in 401(k)s by rank-and-file employees allows for higher limits for key employee contributions. Keeping key employees around with the incentive of higher contribution limits may decrease turnover. Auto-enrollment can be a win for everyone.

© 2017

Susan J. Thomas, CPA, is a senior manager in Lindquist's Chicago office. She has spent more than 15 years in public accounting, working with employee benefit plans of various sizes, complexities and structures. She performs both full and limited-scope audits of defined contribution, defined benefit and health and welfare plans with more than $25 billion in total assets.

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