Encourage Participation in your Retirement Plan through an Automatic Contribution Arrangement

Increasingly popular methods to raise employee participation in defined contribution retirement plans are various “automatic” features. These include auto-enrollment, auto-escalation, and automatically diversified qualified default investment alternatives (QDIAs). Let’s explore the opportunities auto-enrollment, in particular, affords plan sponsors.

There are three forms of auto-enrollment, or automatic contribution arrangements (ACAs).

Basic Auto Enrollment (ACA)

Participants are auto-enrolled unless they elect otherwise
The plan document specifies the percentage of wages that will be deducted each payroll
The participant can elect not to contribute or to contribute a different amount

Eligible Automatic Contribution Arrangement (EACA)

Uniformly applies default deferral percentage to all employees after giving them the required notice
May allow employees to withdraw automatic contributions within 90 days of the first automatic contribution

Qualified Automatic Contribution Arrangement (QACA)

Uniformly applies default percentage to all employees after giving them the required notice
Meets additional Safe Harbor provisions that exempt the plan from the annual actual deferral percentage (ADP) and annual actual contribution percentage (ACP) non-discrimination testing
The default percentage starts at 3% and gradually increases to 6% each year the employee participates, not to exceed 10%
Requires that employees are 100% vested in the match or non-elective contribution after no more than 2 years of service
Does not allow distribution of employer contributions due to financial hardship

Some statistics about ACAs are helpful to review before exploring the advantages and implementation considerations.

Ninety-four percent of plans with the basic ACA offer it to new hires, while 25.4% auto-enroll existing employees either as a one-time sweep or periodic sweep. Ninety percent of auto-enrolled participants increase their contributions, either through auto-escalation or on their own. Ninety-one percent of participants who are auto-enrolled stay in the plan compared with 28% of new hires who must choose to enroll. Of auto-enrolled participants, more than three-quarters remain invested in the QDIA. Particularly in younger participants, auto-enrollment is beneficial because they tend to forego enrolling themselves. Under age 25, 90% who were auto-enrolled stayed in the plan, while less than 2% voluntarily enrolled. Eighty-four percent of workers say that auto-enrollment was key to saving earlier for retirement.

Noneconomic factors can have a major impact on straightforward financial decisions, according to behavioral finance theorists. It specifically affects decisions participants need to make to maximize a successful retirement. Participants see default decisions as informed suggestions and often defer to those default decisions. If auto-enrollment is implemented in an appropriate way, employee participation can increase by 15%-30%. “Auto” features are the “nudge” some participants need-they are not mandatory and they represent the plan architect’s preferences which holds weight with the average participant.

In recent years the initial ACA deferral rate has grown from roughly 3% to 6%. Reports show whether the initial deferral rate is 2%-6%, the participation rate among earners in the $15,000 to $299,000 range remains steady at 85%.

What these statistics tell us, in general, today’s employees are looking to employers to assist in setting them up for retirement success.

Objections from plan sponsors fall into three categories: fear of “telling employees what to do,” thinking employees cannot afford to contribute, and the worry of a line of angry employees who want out of the plan. By utilizing an ACA, employers are not “telling employees what to do.” Entry is not forced as a 30-day notification period is required so employees can opt out. Employers make assumptions about what employees can afford based on requests for raises, stories about hardship, etc. This is a poor assumption for employers to make, as they should let the employee determine whether they want to stay in the plan or not. Implementing an ACA can be set up to capture new hires, avoiding the existing participant base. Plan sponsors should be clear at orientation about the ACA to insure new participants are not surprised.

Advantages to implementing an ACA, for the employer and participant, include several items of note. A retirement plan, with an ACA, can help attract and keep talented workers because it sends the message the employer cares about the employee and is proactive about retirement savings. ACAs increase plan participation among rank-and-file as well as owners and managers. There are significant tax advantages for the employer and participant, including deduction of employer contributions and deferred tax on contributions and earnings until distribution.

If this information leads you to consider implementing an ACA for your plan, here are some things you should consider.

Choose the correct deferral level

Consider 6%, or at least up to your current match
Choosing too low may drive participants who considered contributing higher to go with the “auto-pilot” lower deferral rate

If you are implementing an EACA or QACA, plan for the required match prior to implementation

Look at your eligibility period

Shorter eligibility periods work better with auto-enrollment
Longer eligibility periods dramatically decrease acceptance

Consider your employee base

High-turnover or larger numbers of lower paid employees with inconsistent hours may lead to being more of a burden than a benefit to the plan and its administration

To explore the advantages of adding auto-enrollment to your defined contribution retirement plan, partner with your team in the Retirement Plan Division at Greenleaf Trust. Your team is here to help you work through the considerations, will adjust your current documents and assist in best practices for employee notification and acceptance.