The Pros and Cons of 401(k)/403(b) Automatic Enrollment

Automatic enrollment has increasingly become a common feature among employer-sponsored retirement plans and continues to feature in conversations around improving the overall retirement health in the US. As the conversations continue to swirl around automatic enrollment, and more and more plans adopt the feature, plan sponsors will inevitably be faced with the decision whether or not to add automatic enrollment to their plan. While nothing can replace the advice and guidance of a qualified fiduciary advisor, here are a few pros and cons of automatic enrollment that plan sponsors should consider when making their decision:

Pros

1. Increased participation rate. This may seem like a no-brainer, but when a plan implements automatic enrollment, employees’ participation rate in the plan typically increases. If the plan only offers automatic enrollment to new hires (this is true for most plans with automatic enrollment), the participation rate will increase gradually over time as new employees are automatically enrolled. However, employers looking to increase participation among current employees may also do a one-time or recurring automatic enrollment sweep, in which case both new and existing employees that are not participating would be automatically enrolled in the plan (unless they opt-out). The addition of the auto-enrollment sweep can have a much more dramatic and significant impact on participation rates.
2. Improved retirement outcomes. This again may seem like an obvious one, but it is so important. When a plan implements automatic enrollment, employees that otherwise may have chosen not to save, or simply not taken any action to set up their retirement savings, will be automatically set to contribute. This will help them save more for retirement and (hopefully) be able to retire comfortably when the time comes. The sooner the better when it comes to retirement savings, so automatically enrolling employees when they first start is a great way to help them build their retirement savings.
3. Improved non-discrimination testing results. As a plan sponsor, you are responsible for ensuring you meet your fiduciary duty, and that the plan meets non-discrimination requirements on an annual basis. Without automatic enrollment, the majority of non-participating employees are likely to be non-highly compensated employees (NHCEs). This can create problems when it comes time for non-discrimination testing, as it can lead to the average contribution rate for NCHEs to be lower, limiting the amount that highly-compensated employees (HCEs) and key employees can contribute to the plan. Automatically enrolling employees into the plan improves participation among NHCEs and ultimately can improve non-discrimination testing results.

Cons

1. Potentially increases the cost of the plan, particularly if the employer provides a matching contribution, or pays any of the plan costs as a corporate expense. With more employees actively contributing to the plan due to the automatic enrollment, and per-head costs will increase. If the plan sponsor pays these costs directly, the cost of maintaining the plan will increase. Likewise, if there is a company match, employees that are newly automatically enrolled will also be newly eligible to receive the employer match, meaning the company will have to cut a bigger check to cover the matching contribution.
2. Potentially creates complacency among employees. While automatic enrollment is largely good for employee retirement savings, it can also have the effect of making employees feel as though everything is being taken care of for them. They may choose to never increase their contribution from the automatic enrollment amount (unless an automatic escalation feature is also added), or neglect to check on their retirement savings over time. It is important that employees be educated on retirement savings best practices to avoid these issues.
3. Potentially leads to an increased number of participant loans. While we would all like to believe that employees have managed their finances to accommodate retirement savings AND emergency savings, the harsh reality is that a staggering number of individuals are living paycheck-to-paycheck, regardless of their income level. When retirement savings are automatically deducted from their pay, it can make an already tight situation even more tenuous. This may lead to employees taking loans and/or other withdrawals from the retirement plan to cover emergency expenses, which can be detrimental to retirement outcomes. It is important that automatic enrollment be coupled with a complete financial wellness solution to help employees take charge of their finances and avoid hurting their retirement via loans and withdrawals.

Automatic enrollment can be largely beneficial to both plan sponsors and the employees they serve, so long as the potential drawbacks of the feature are kept in check. A fiduciary retirement plan advisor can help plan sponsors effectively and efficiently implement automatic enrollment into their plan and create better retirement outcomes for their employees.