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401(k) Automatic Enrollment - Things to Consider

At first glance, adding an auto enrollment feature to your Company’s 401(k) Plan appears to be a simple way to increase Plan participation.  In practice, there can be some unintended consequences in implementing auto enrollment.  Below are some potential hurdles and adjustments you may want to consider to get the desired effects.

Passive enrollment programs often lead to employees deferring minimum percentages of compensation as mandated by the auto enrollment program.  A 401(k) benchmark study conducted by Aon Hewitt found that while participation rates greatly increase with auto enrollment, the average savings rates actually decrease as sponsors set the default rates too low.  The study shows average savings rates of 6.6% for plans with auto enroll versus 7.9% for plans without auto enroll.

Non-compliance can be costly!  Great care and planning are warranted when structuring the language used in drafting the Amendment allowing auto enrollment.  Both the IRS and Department of Labor have strict compliance requirements and corrective action is needed if employees are not enrolled timely.  This corrective action will require that the Company enroll the employee and make contributions on the employee’s behalf equal to 100% of any employer matching contributions and a calculation to fund lost earnings. 

1.    Employees may elect out of participation resulting in participant accounts being created containing a few weeks’ worth of contributions.  This drives up headcount, administrative costs and small balances that have to be dealt with.

These (and many other) plan operational failures can be mitigated by using vague clauses versus steadfast language when drafting plan amendments.  When describing the auto enrollment effective date, consider using phrases such as “as soon as administratively feasible” versus “on the first day of employment”.  It is also worth considering using an effective date of the first day of the month following 30 days of employment.  This allows the payroll department to audit for compliance once a month versus every payroll period and also gives new employees time to express their desire not to participate before any withholdings are processed.

With proper planning and foresight, an auto enrollment process can be designed that achieves the desired objectives and doesn’t negatively impact the costs incurred by the Company.