Help employees save for retirement with auto-enrollment and auto-escalation

Help employees save for retirement with auto-enrollment and auto-escalation
Until a decade ago, employees had to affirmatively choose to participate in a company’s 401(k) plan, and the onus was on employees to understand the plan and determine an effective saving strategy based on their individual goals. However, the Pension Protection Act of 2006 gave employers the ability to jumpstart their employees’ retirement savings through plan features including auto-enrollment and auto-escalation. Plan sponsors that aren’t utilizing these features should consider whether they are right for your plan.

Help employees save for retirementWhat is auto-enrollment?

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

  • Employees are automatically enrolled in the plan unless they elect otherwise.
  • The plan document specifies the percentage of wages that will automatically be deducted.
  • Employees can elect to contribute a different percentage of pay.

2. Eligible Automatic Contribution Arrangement

  • The plan sponsor uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice.
  • Employees might be allowed to withdraw automatic contributions, including earnings, within 90 days of the date of the first automatic contribution.

3. Qualified Automatic Contribution Arrangement

  • The plan sponsor uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice.
  • This arrangement meets and additional “safe harbor” provision that exempts the plan from annual actual deferral percentage and actual contribution percentage nondiscrimination testing requirements
  • The default deferral percentage starts at 3 percent and gradually increases to 6 percent with each year that an employee participates. The default percentage cannot exceed 10 percent.
  • The required employer contributions are as follows. Employers can either:
    – have a matching contribution: 100 percent match for elective deferrals that do not exceed 1 percent of compensation, plus 50 percent match for elective deferrals between 1 and 6 percent of compensation; or
    – have a non-elective contribution: 3 percent of compensation for all participants, including those who choose not to make any elective deferrals

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.

What is automatic escalation?

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.

Employee engagement and education

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.

MOST PENSION PLAN LIMITATIONS WON’T CHANGE IN 2016. The Internal Revenue Service announced pension plan limitations will not change in 2016, because the modest increase in the cost-of-living index did not meet thresholds for adjustment.
ARE YOUR EMPLOYEE BENEFIT PLAN’S FEES REASONABLE? The Department of Labor’s 408(b)(2) fee disclosure regulations require service providers to disclose how much employee benefit plan sponsors are paying in fees.
“FAILSAFE” DETERMINATION LETTER PROGRAM IS GOING AWAY. Beginning in January 2017, the IRS is abolishing the staggered five-year amendment cycle for individually designed plans and will not accept determination letter applications based on the five-year cycle. If your organization offers an individually designed plan, this means you’ll face significantly higher burdens in order to stay in compliance.

Posted By Heidi Chick, CPA, and Kody Ferrin on 12-16-2016 | Topics: Articles, Employer, Newsletters, Resources,