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For auto enrollment, the proof is in the pudding

For auto enrollment, the proof is in the pudding

Nicolle Willson, J.D., CFP®, C(k)P®

Auto enrollment provides a lot of benefits to employers and employees, yet it doesn’t quite get the credit it deserves. How auto enrollment works is fairly straightforward: when employees become eligible to join your 401(k) plan, they are automatically enrolled. But there is a common misconception that it forces employees to participate in the company 401(k).

Rather, all eligible employees can choose to opt in or opt out of the plan. If an eligible employee takes no action before the stated deadline, they will be automatically enrolled at a pre-determined contribution rate. Eligible employees can opt in or opt out at any time.

What auto enrollment helps combat is participant inertia. Investment portfolios, target date funds, expense ratios, contribution rates—these are all terms that can be confusing and cause inaction. Auto enrollment can take indecisiveness and procrastination out of the picture.

On auto enrollment plans, employers choose a default contribution rate and a default investment portfolio for people who do not make the selections themselves.

Studies have even shown that employees embrace higher savings rates because they trust that their employer knows best and will choose a contribution rate to help them save for retirement. This is the biggest benefit of auto enrollment: increasing employees’ retirement readiness.

But before we get into the additional benefits of auto enrollment, let’s take a look at the numbers.

An analysis of industry auto enrollment plans

401(k) plans are a popular workplace benefit 88% of workers say they’re a must have. Yet, when participation is voluntary, only 57% enroll—likely due to employee interia. When a plan has auto-enrollment, 90% of employees participate and contribute.

By defaulting your employees into your 401(k) plan with an auto enroll feature, you can provide a seamless path to saving for your employees. Additionally, you can  increase your employee participation rate and help your employees reach their savings goals with minimal effort.

Given these impressive numbers, it’s no wonder that as of 2019, 69% of all 401(k) plans included an auto enrollment feature. Auto enrollment is a common feature, not an exception.

A 2018 survey found that the national default contribution rate for automatic enrollment was expected to hold steady in 2019 at an average of 4.6%. (This is about half of the contribution rate on average at Guideline.) What this tells us is that employees do not shy away from auto enrollment.

Automatic enrollment doesn’t just benefit those who can afford to contribute. Quite the opposite, in fact. It has been shown to increase access to the workers who most need help with retirement savings (minorities and low-income earners)—doubling participation rates among individuals earning less than $30,000/year.

Another study showed that participation rates among 20-29 year-olds in an auto enrollment plan was 84% versus 31% in non-auto enrollment plans.

Collectively, these stats show that auto enrollment can increase retirement preparedness, and therefore, financial wellness, for those traditionally marginalized in the workforce—minorities, low-income earners, and young professionals.

Additionally, providing a 401(k) with auto enrollment can help your employees build their nest egg sooner, so they can benefit from compounding interest over a longer time horizon.

According to a 2017 study conducted by Vanguard, nearly half of plans they surveyed use automatic enrollment, which represents incredible growth to the tune of 300%. This rise in popularity is a testament to its many benefits.

This same study showed that plans with default deferral rates of 4% or more have doubled to 48%, while plans with a rate of 6% or higher have nearly tripled to 20%. This data indicates that auto enrollment is here to stay, and we believe it will continue to trend upward.

A look at Guideline’s auto enrollment plans

We’ve shown that auto enrollment can help increase participation rates. For employers, this increase can make their business more likely to pass most IRS nondiscrimination testing.

Based on our own internal research, we see that plans with a default deferral rate of at least 4%, had a 75% passage rate. We then looked at companies with a Traditional 401(k) plan (these plans don’t automatically satisfy most IRS nondiscrimination tests) and found that 40% that would have otherwise failed, ended up passing—which we believe is likely due in part to a higher participation rate.

Employers on auto enrollment plans pick a default contribution rate for everyone that is auto enrolled. This can create another challenge—set it too high and your employees may opt out, but set it too low and your employees may not save enough for retirement.

We looked at the data to see if our businesses had chosen a low automatic enrollment rate or a high one. Our analysis revealed that 88% of Guideline plans have a default deferral rate of 4% or higher, while the average contribution rate across all Guideline plans is 8.73%.

Needless to say, we are very proud of the employers and employees on our platform that have beat the expected national average of 4.6%. We’ve built our 401(k) product to make saving as simple and seamless as possible to increase retirement readiness, and our built-in auto enrollment feature helps us toward that goal.

As an employer, you chose to offer a 401(k) to help your employees increase their retirement readiness and to help your business. Auto enrollment can help further both  objectives in a variety of ways:

  1. Simplified saving process for employers and employees
  2. Increased savings towards retirement
  3. Improved IRS nondiscrimination testing results
  4. Employee recruiting and retention boost

We built Guideline to provide small business owners with an easy, affordable workplace benefit. And to help more people save for retirement. 401(k) plans with automatic enrollment help us work toward both goals.

Get started with Guideline today

Auto enrollment FAQs

How will auto enrollment affect recruiting or retention?

A 401(k) can be a very effective employee recruiting and retention tool. A recent study found that 90% of workers would think twice about accepting a job without a 401(k) benefit. With it, you can show your valued employees and prospective quality candidates that you care about their financial future by investing in their retirement security now.

By offering an auto enrollment plan, you make investing easier and encourage good saving habits. This can boost employee morale and confidence, and provide peace of mind.

What should I set as the default deferral rate?

The industry standard for smaller 401(k) plans is 6% however, you should choose a default rate that works for your plan. One factor we believe might be helpful to consider is choosing a default that at least maximizes the employer match, if applicable. Whatever you decide is best for your business, you must at least choose a default rate between 1-10%.

As mentioned earlier, a higher automatic contribution rate can potentially help plans pass most annual IRS nondiscrimination testing.

Designed to level the playing field, these tests require highly compensated employees (HCE) and key employees to stay within specific contribution rates and account balances in relation to non-highly compensated employees (NHCE) and non-key employees. Automatic enrollment can help increase the participation rates and average contribution rates of NHCEs.

This, in turn, can help improve test results and allow HCEs to enjoy more benefits from the 401(k).

Should I incentivize my employees to contribute?

As we mentioned above, having an auto enrollment feature generally increases participation rates by default, but if you still need more incentive to get your employees to contribute, you could offer a match to employees to reward their contributions. For example, offering a match of 100% up to 3% means matching 100% of your employee’s contribution up to the first 3% they contribute from their paycheck.

If they contribute 1%, you only need to match 1%. If they choose to contribute 5%, you are capped at your 3%. Employer matches are a great way to decide beforehand exactly how much you will be contributing to each employee’s 401(k) to help you plan and monitor your business expenses.

An added benefit of an employer match is the tax deduction you can get from making them! The IRS/tax code is all about helping people save for retirement. One of the ways they do this is encouraging companies to offer retirement benefits by giving them tax credits for doing so.

Every employer contribution you make to your employees’ 401(k) account is tax-deductible. So you’re providing an ongoing benefit to your employees, while receiving tax deductions in the process. On top of that, you may also be eligible for tax deductions in administrative fees incurred to manage your 401(k). Learn more about the Retirement Plans Startup Costs Tax Credit.

You may be eligible for yet another tax credit under the Retirement Plans Startup Costs Tax Credit.  If you are an eligible employer that has an auto-enrollment feature in your plan, you may be eligible to claim a tax credit of $500 per year for a 3-year taxable period, beginning with the first year you include the auto-enrollment feature.

This information is for educational purposes only and is not intended to be construed as investment or tax advice. For more information, consult a qualified financial or tax advisor.