Employees Not Saving for Retirement? Consider Auto-Enrollment
Employees who push back that start date for retirement savings will have a hard time catching up — and may wind up on your payroll longer than you might prefer. For example, an employee who starts saving at age 25 and stops at 65 will, assuming a seven percent average annual return, wind up with more than twice the amount as the employee who starts at 35.
What can you do to help?
Setting Up an Auto-Enrollment Plan
The steps for setting up a plan with auto-enrollment features are essentially the same as setting up any qualified plan. Here is an abbreviated version of the steps that the DOL lists in an article on this topic directed to smaller employers:
Adopt a written plan document: Plans begin with a written document that serves as the foundation for day-to-day plan operations. Before adopting a plan document, you will need to decide on the type of automatic enrollment 401(k) plan that is best for you.
Arrange a trust for the plan’s assets: Assets of an automatic enrollment 401(k) plan must be held in trust to assure that they are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments and distributions.
Develop a record-keeping system: An accurate record-keeping system will track and properly attribute contributions, earnings and losses, plan investments, expenses and benefit distributions. It will also provide a record of employees who elect not to participate as well as participant contribution and investment decisions.
Provide plan information to employees eligible to participate: You must notify employees who are eligible to participate in the plan about certain benefits, rights and features. Employees must receive an initial notice prior to automatic enrollment in the plan and receive a similar notice each year.
According to the Department of Labor (DOL), about 30 percent of workers are eligible but don’t participate in a 401(k) plan. That proportion could be cut in half if employers adopt auto-enrollment features, the DOL estimates. That message hasn’t gotten through to everyone. Or in many cases it has, but employers are reluctant to take that step, for various reasons.
Surveys on the prevalence of auto-enrollment vary considerably, based upon the sample base. For example, one such survey issued by Aon Hewitt last month found that 70 percent of employers auto-enroll new participants.
And a high proportion — 62 percent — also has auto-escalation features built into their auto-enroll program. Those that don’t employ auto-escalation express “concern about employee reaction,” or “cost of employer match.”
Capping Auto-Escalation
Two-thirds of employers with auto-escalation place a ceiling on the automatic annual ratcheting-up of deferrals higher than the top deferral rate that is eligible for an employer match. The most common reasons for not doing so are the same given for not doing auto-escalation in the first place.
Aon Hewitt’s survey provides a window into the practices of very large companies, that is, the consultant’s client base. Another survey by membership organization WorldatWork, incorporates data from smaller companies. Its latest “Trends in 401(k) Plans” found 56 percent of employers offering auto-enrollment, with about half of them also auto-escalating deferral rates. Another 18 percent report they are considering adopting auto-enrollment, but the remaining employers say it’s not in their game plan.
How much is deferred? The most prevalent initial deferral rate for the auto-enroll plans in the WorldatWork survey was 3-3.99 percent, and nearly all of the auto-escalators bump up participants’ annual rates in increments 1-1.99 percent.
Potential Benefits
The Labor Department is a big fan of auto-enrollment, and the benefits it believes come from the practice are varied. According to the DOL, auto-enrollment:
- Helps attract and keep talented employees,
- Increases plan participation among both rank-and-file employees and owners/managers,
- Allows for salary deferrals into certain plan investments if employees do not select their own investments, and
- Simplifies selection of investments appropriate for long-term retirement savings for participants.
The DOL offers no evidence of the first benefit, but the others are logical. And the importance of having employees’ 401(k) savings and employer matching contributions invested in appropriate funds — made possible by ERISA’s Qualified Default Investment Alternative (QDIA) options — is huge. Employees often fail to act (both in deciding whether to participate and in choosing investments) out of fear of making a mistake.
Just as delaying entry into the retirement savings game can have enormous consequences, so too can choosing the wrong investment option. For example, the difference between the ultimate retirement savings accumulated (assuming, for simplicity’s sake, flat annual contributions of $5,000) over 35 years at a four percent average return would be $383,000, only a little more than half the $740,000 that the 401(k) participant would wind up with assuming an achievable seven percent return.
The ultimate dollars would be significantly higher, of course, due to increasing contribution amounts, but the basic point remains valid.
Most Common Default Investment
The target date fund model QDIA is by far the most widely chosen, although not necessarily the best for all plans. Not all target date plans are the same, of course, and those tires must be kicked firmly. You can find help analyzing target date fund offerings by downloading this pdf: http://www.dol.gov/ebsa/pdf/fsTDF.pdf
Auto-enrollment is anything but a panacea for getting your employees on track to retire when they still have ample time to enjoy life, particularly when current employees are automatically re-enrolled. For example, if an employee was deferring eight percent of her salary, but the auto-re-enrollment drops her to a default deferral rate of only four percent, things are moving in the wrong direction.
The same could occur for a new-hire who had previously been saving aggressively at his former employer, but being auto-enrolled at a lower level could cause him to backslide and just stick with the lower deferral rate.
In both of these scenarios, however, you can work directly with the employees to restore their higher deferral levels.
