401(k) Automatic Enrollment: What You Need to Know

Setting up 401(k) automatic enrollment could help increase the number of employees participating in your 401(k) plan.

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How to properly implement and manage 401(k) automatic enrollment at your company

Do you want to increase your 401(k) participation rate? If so, automatic enrollment may be the answer. But before you offer automatic enrollment, make sure you have a sound understanding of this feature.

What is automatic enrollment?

Automatic enrollment enables employers to automatically “enroll” employees in the company’s 401(k) plan — unless the employee chooses not to participate.

Automatic enrollment enables employers to automatically “enroll” employees in the company’s 401(k) plan — unless the employee chooses not to participate.

The Internal Revenue Service (IRS) says “enroll” means “that the employer contributes part of the employee’s wages to the retirement plan on the employee’s behalf.” In other words, the employer automatically deducts the employee’s 401(k) contributions from their wages when running payroll.

Automatic enrollment can be used not only for 401(k) plans but also SIMPLE IRA, 403(b), and governmental 457(b) plans.

What are the different types of 401(k) automatic enrollment?

There are 3 major types:

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

  • You automatically enroll your employees in your 401(k) plan, unless they choose otherwise.
  • Your 401(k) plan document must state the percentage that will be automatically deducted from employees’ wages.
  • Employees can choose to contribute a different percentage, or they can elect not to contribute to your 401(k) plan.

2. Eligible automatic contribution arrangement (EACA):

  • An EACA is similar to basic automatic enrollment, except that it has certain notice requirements.
  • Participants who are automatically enrolled via EACA can withdraw their automatic contributions within 90 days of their first automatic contribution.

3. Qualified automatic contribution arrangement (QACA):

  • A QACA has various requirements — including annual testing, employee notification, employer contributions, special vesting schedule, and fixed schedule for employee contributions.

For more information on the 3 types of automatic enrollment, visit the IRS’ website.

What is the average deferral rate for automatic enrollment?

The employer sets the default percentage to be automatically deducted from participants’ wages. Participants should be given the opportunity to change the default amount.

The Financial Industry Regulatory Authority says that although most employers use a 3% default percentage, a growing number of employers are enrolling their employees at 5 or 6% or higher. In 1 survey, 83% of participants say they’re fine with automatic enrollment at 6%.

Some employers bump up the initial percentage over time. This process is called “automatic escalation.”

What is automatic escalation?

Automatic escalation is a 401(k) plan feature that automatically increases employees’ contributions over time. For example, you may increase employees’ 401(k) savings amount by 1%, 10%, or higher.

Note that the Setting Every Community Up for Retirement Enhancement (SECURE) Act increases the cap on default contributions, from 10% to 15%. This means you can automatically escalate an employee’s contributions to no more than 15% of their pay. However, the employee can choose to contribute more than 15% of their pay.

Employers and employees are increasingly embracing automatic enrollment. According to 1 industry report, 69% of defined contribution (DC) plans offered automatic enrollment in 2019, compared to 60% in 2016. Most DC plans come in the form of a 401(k).

In one study, 84% of employees say automatic enrollment made them save for retirement sooner than if they had to make the decision themselves. Moreover, 90% of employees remain in their 401(k) plan after being automatically enrolled. Another survey shows that automatic enrollment triples the participation rate of new hires to 91%, compared to 28% for voluntary enrollment.

84% of employees say automatic enrollment made them save for retirement sooner than if they had to make the decision themselves. Moreover, 90% of employees remain in their 401(k) plan after being automatically enrolled.

What are the benefits of automatic enrollment?

  • Helps attract and retain qualified employees
  • Boosts 401(k) participation rate among new hires, rank-and-file employees, and managerial staff
  • Employers can make certain investment choices for automatically enrolled employees who do not choose their own investments. (You must give employees the option of changing the investment selection.)
  • Helps employees start saving for retirement sooner
  • Provides tax credits to small employers who establish a 401(k) with automatic enrollment
  • Offers tax savings on certain employer and employee 401(k) contributions

Can employers force employees to have automatic enrollment?

Currently, automatic enrollment is voluntary for employees, meaning you cannot force employees to participate. But this could change, due to pending legislation.

Members of Congress have introduced the SECURE Act 2.0, which builds on the original SECURE Act. The new version would require employers to automatically enroll eligible employees in the company’s 401(k) plan at a deferral rate of between 3% and 10%. The default rate would automatically escalate annually at 1%, up to a minimum of 10% and a maximum of 15%. Employees can choose to contribute a different amount.

“Secure 2.0 has broad bipartisan support, and there is a significant likelihood that it will pass this year, either as a standalone or as part of broader legislation,” one expert says in a May 2021 article published by the Society for Human Resource Management.

How can employers set up 401(k) automatic enrollment?

The initial steps for setting up an automatic enrollment 401(k) plan include the following:

  • Determine the best automatic enrollment 401(k) plan for your business. For example, basic automatic enrollment, EACA, or QACA.
  • Develop and maintain a written plan document that serves as a guide for the plan’s day-to-day operations.
  • Select a trustee for the plan’s assets. The trustee should ensure that the 401(k) plan assets are utilized only for the benefit of participants and their beneficiaries.
  • Create a recordkeeping system to track and allocate contributions, plan investments, earnings and losses, distributions, and expenses.
  • Give employees the appropriate notices about the plan. This includes a Summary Plan Description (SPD) and an initial notice prior to automatic enrollment.

You can hire a third party administrator to help you set up the automatic enrollment 401(k) plan, or you can establish it yourself. If you hire a third party administrator, they can also assist with the day-to-day management of the plan, including filing reports with government agencies like the IRS and the United States Department of Labor.

Communication is essential to success

There’s a strong case for 401(k) automatic enrollment. But to truly work, the feature must be properly implemented and managed. One of the main criteria for success is communication. To decrease employee resistance, you’ll need to communicate the automatic enrollment program effectively to your employees — including the program benefits and any procedures for opting out.

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