LAST REVIEWED Apr 05 2021 5 MIN READ
By The Human Interest Team
The Internal Revenue Service defines automatic enrollment (also known as automatic contribution arrangement) as “a feature in a retirement plan that allows an employer to ‘enroll’ an eligible employee in the employer’s plan unless the employee affirmatively elects otherwise.”
How does automatic 401(k) enrollment work?
In this set-up, a portion of the employee’s wages are placed in the retirement plan on the employee’s behalf. The employer automatically reduces an employee’s wages by a default percentage and contributes that amount to the employee’s plan account as an automatic enrollment contribution. Behavioral economists recommend this plan for “opt-out” vs. “opt-in” behavior.
Pros of automatic 401(k) enrollment
When I first entered the workplace, I was not concerned with retirement. I was focused on the largest possible deposit in my bank account every other week. Despite my employer’s best attempts, it took me more than two years to enroll in the 401(k) plan they offered. This is when the “if I knew then what I know now” statement comes to mind. If only automatic enrollment had been in place at that time, I would have started contributing to my retirement much earlier.
Apparently, I’m not the only person who could have benefited from autoenrollment. As Time.com reported, researchers found that “plans with auto-enrollment had 32% more participants, and those with an auto-escalation feature had 46% more participants increasing their contributions.”
The benefits of increased participation are encouraging employers to use automatic enrollment more often for their retirement investment plans. A survey of large U.S. employers found that 68 % of the surveyed companies automatically enroll workers in 401(k) plans.
Cons of automatic 401(k) enrollment
Although automatic enrollment increases participation rates, some researchers are concerned that it leads to lower contribution rates in cases when default deferral rates are at low levels.
“Auto-enrollment policies are very successful at raising participation rates but may not boost workers’ total retirement saving if firms aim to keep their 401(k) compensation costs at a constant level,” according to research from the Center for Retirement Research at Boston College.
Due to the risks of employees gaining a false sense of security, or setting their investments on auto-pilot, some employers are trying “auto-escalation” to encourage plan participants to increase their savings via automatic contribution increases.
In context of other employee benefits
Unfortunately, today’s employees face information overload re: employee benefits and personal investment options. A lack of confidence in making the “right” choices can deter them not only from investing in their employer-sponsored retirement savings, but also prevents them from making choices for their health and wellbeing when it comes to health insurance, HSAs, FSAs, etc. Employers are also using auto enrollment is to ensure eligible employees are enrolled in a health insurance plan, as well as investing in disability insurance. In some cases employers use “active enrollment” which requires employees to respond with a yes or no to all benefits offered to them. Requiring this action can lead to better participation rates while also ensuring employees have the insurance coverage they need.
Automatic 401(k) enrollment combined with automatic escalation, with appropriate opt-out provisions in place, can turn lack of action into a powerful tool to boost both participation and deferral rates. These options can mean the difference between a financially secure retirement and one burdened by financial issues for your employees. Through simplification, and efforts to educate workers about 401(k) plans, employers can encourage employees to prepare for retirement early in their careers which will hopefully yield better long-term results for both them and the company.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.