Automatic enrollment allows employers to automatically enroll all eligible employees in the plan and deduct elective deferrals from the employee’s wages. The deferrals are set at a specific amount unless the employee makes an affirmative election not to contribute or to contribute a different amount. Any plan that allows elective salary deferrals can have this feature.
Before any wages are withheld, employers must give employees the option to have none withheld or to have a different amount withheld. Employees can also have the option to withdraw their money within 90 days of the date that the first automatic contribution was made depending on the employer’s plan. In addition, the percentage automatically withheld must apply uniformly to all employees covered by the plan and not exceed 10 percent of salary.
The three types of automatic enrollment
1. Basic automatic enrollment, or Automatic Contribution Arrangement
2. Eligible Automatic Contribution Arrangement
3. Qualified Automatic Contribution Arrangement
Benefits of auto-enrollment
There are many benefits of automatic enrollment into retirement savings plans. One is that this process provides better benefits to improve employee morale, retain talent and improve recruitment. This also allows employees to feel more secure about their retirement.
In addition, employers who implement automatic enrollment provisions will no longer be subject to certain nondiscrimination rules, which can benefit higher-paid employees. This can be a good way help to retain highly paid key executives.
Finally, this option can increase participation in the plan, which in turn increases retirement savings for all the company’s employees, since employees now must make an election to opt out, versus opting in. Most employees will remain in the plan.
Because employees are less likely to increase their savings rate on their own, the employer can add an automatic escalation feature to the plan. Through auto-escalation, the deferral increases each year at pre-determined intervals based on the year of participation; for example, year one at 3 percent, year two at 4 percent, and year three at 5 percent. At each interval, the contribution amount is typically increased by 1 percent every year until it reaches its preset maximum.
The advantage of the auto-escalation feature is that it increases the amount set aside for retirement purposes without the employee having to do anything. Most plans set their default contribution rate at only 3 percent, which is much lower than needed to effectively save for retirement. Auto-escalation increases that amount annually, increasing the amount being saved. It has also been found that people are less likely to increase their savings on their own.
However, even auto-escalation isn’t the complete answer; if there is only a 1 to 2 percent increase every year, it will take a very long time for people to reach the 12 to 15 percent threshold generally considered necessary for having a secure retirement.
To solve this, employers should be proactive in educating their employees on how much is necessary to save, such as retirement savings calculators, gap analyses, risk tolerance, investment options and other general educational materials. Auto-enrollment helps get employees into the plan and auto-escalation helps them increase their rate of saving, but employers must continue to engage and educate their employees to help them fully understand and participate in planning for their retirement. After all, this is one of the ultimate reasons employers offer the plan.
For more information, you can visit the IRS Retirement Plan FAQ page.
For questions about auto-enrollment and auto-escalation and how it could affect you or your employees retirement, please call your WK advisor at (573) 442-6171 or (573) 635-6196.