[IMGCAP(1)]There has been a significant trend in recent years to add automatic features to 401(k) retirement plans.
The most common, automatic enrollment, is a feature that automatically enrolls new participants in a company’s retirement plan once they’ve met the plan’s eligibility requirements. At no cost to the plan sponsor, this is a great way to help employees prepare for retirement.
The topic of automatic enrollment and retirement readiness in general provides another opportunity for accountants to provide valued counsel to their business clients.
Accountants can help their business clients by advising them on 401(k) enrollment in their role as trusted advisors.
Since the establishment of automatic enrollment (otherwise known as an automatic contribution arrangement) under the Pension Protection Act of 2006, plans that have added this feature have experienced increased plan participation rates. In a recent study by Aon Hewitt, plans with automatic enrollment had an average participation rate of 84.6 percent, compared to 63.5 percent for plans with no automatic enrollment feature.
These numbers seem to tell a great story for automatic enrollment. However, analyzing the survey results further reveals an interesting trend related to average savings rates.
The Aon Hewitt survey discovered that plans with automatic enrollment had an average savings rate of 6.6 percent, whereas plans without automatic enrollment had an average savings rate of 7.9 percent. According to this study, automatic enrollment actually appears to have a negative effect on savings rates, as most auto-enrolled participants remain at the default rate. Average default contribution rates for plans with automatic enrollment are 3.4 percent, according to a 2013 survey by the Center for Retirement Research at Boston College.
While an automatic enrollment feature clearly has benefits for increasing participation, additional strategies need to be considered to drive increases in average savings rates to prepare participants for retirement. Accountants and their clients should consider several approaches when analyzing a plan’s strategy for getting participants ready for retirement. Among those to be considered include:
Pairing automatic enrollment with automatic escalation: Pairing these features is a smart way to increase average savings rates. The escalation feature should be designed in a way to encourage participants to contribute at a rate that triggers receipt of the maximum match rate, if applicable.
“Backsweeping” employees who are not participating in the plan when implementing automatic enrollment: Implementing this strategy ensures all eligible employees are enrolled in the plan, and helps reinforce the retirement readiness message to participants. Of course, employees who do not wish to participate in the plan can opt out at any time.
Stretching the match formula to encourage participants to save more while receiving the same matching dollars: The Aon Hewitt study found that 30.3 percent of participants save at a rate to receive the maximum match. If a plan’s match formula is stretched so a participant has to contribute more to receive the maximum match, this will promote better retirement savings.
Adding a Roth provision to a plan to encourage better savings rates: The Aon Hewitt survey found that participants who made Roth contributions saved at an average rate of 10.2 percent, compared to non-Roth contributors at 7.7 percent.
While the addition of automatic enrollment to a 401(k) plan presents a simple way to increase participation, it can also have unintended consequences. Whether implementing a retirement plan for your firm, or advising clients on the subject, consider the best interests of your small business clients’ most precious asset, their employees.
Mike Trabold is director of compliance risk at Paychex.
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