Only 25 percent of the
300 mid- to large-sized employers polled in a survey by global HR-services company
Hewitt Associates said they viewed a high participation rate in their 401(k)
plans as the prime measure of the plans’ success. The survey indicated that
more employers are placing less importance on the number of employees enrolled
in their 401(k) plans and redirecting their focus toward the quality of the
plans they offer. Many employers automatically enroll employees in a plan,
often at a 3 percent default contribution rate, but doing so may not
necessarily hinder quality enrollment. Here we discuss issues to consider when
implementing automatic enrollment, offer insight into compliance issues that
may arise with automatic enrollment, and provide tips for fostering quality
plan enrollment.
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Automatic Enrollment
Here to Stay
A December 2007 report
by the Pennsylvania-based investment management company Vanguard reveals that
automatic enrollment improves plan participation rates and that individuals who
are automatically enrolled in a plan will eventually take ownership of their
contribution rate. The report, entitled “Measuring the Effectiveness of
Automatic Enrollment,” states that more than 50 percent of employees
automatically enrolled for about seven months were at the default contribution
rate, while one-third had increased their contribution rate above the initial
default. After 21/2
years, only
20 percent were at the default rate, while nearly 60 percent had increased
their contribution rate above that amount.
Also at the time the
Hewitt study was released in 2006, the U.S. Department of Labor (DOL) and the
IRS were busy filing rules governing automatic enrollments. The DOL rule, which
went into effect in December 2007, provides a safe harbor for plan fiduciaries
that invest plan participants’ assets if the participants do not provide
investment direction. (See CCBA January 2008
for more on the DOL
rule.) The IRS’s proposed regulations would allow an employee to opt out of an
automatic contribution arrangement and would permit the plan administrator to
return the deferred amounts to the worker within 90 days of the first default
elective deferral—that is, the first instance when a contribution is
automatically made—without assessing him or her a 10 percent early withdrawal
tax. The final IRS regulation, which should go into effect this winter, will be
applied retroactively to plan years beginning on or after Jan. 1, 2008.
Compliance Is an Issue
Although the federal
regulations give employers the right to automatically enroll employees in their
plans, employers are not immune from liability associated with their selection
of the plans they offer. Employers could encounter several legal pitfalls
concerning automatic enrollment as a result of these regulations; namely, regarding
plan selection and issuing notices to employees about their automatic
contributions and their right to direct their money somewhere other than to the
default plan. “Employers have a duty to prudently select and periodically
monitor the plans they select,” says Jason C. Roberts, Esq., CCBA board
member and senior associate and head of the retirement plan and investment
adviser consulting group in the Hermosa Beach office of the law firm Edgerton
& Weaver, LLP.
Further, an employer
could be held liable under the federal Employee Retirement Income Security Act
for financial losses occurring because of imprudent plan selection, Roberts
explains. Also, he adds, the types of notices employers must provide about
automatic enrollment are rigorous; therefore, before launching automatic enrollment,
consult an attorney who can explain how to comply with the federal regulations.
Beyond Automatic
Enrollment
While automatic 401(k)
enrollment may have gotten a boost from the federal government, employers should
not, as a general rule, rely on it exclusively to maintain plan participation
rates. “[S]imply automatically enrolling employees into the 401(k) plan will
not get workers where they need to be in terms of retirement savings,” said
Pamela Hess, director of retirement research at Hewitt Associates, in a recent
release.
Hess recommended that
employers should pay attention to “quality enrollment.” This has more to do with
picking appropriate default contribution rates and funds as a way to keep
automatically enrolled individuals interested in their retirement strategy and
on a path toward saving an appropriate amount of money for retirement than it
does with passive enrollment. To achieve this, consider taking the following
steps:
1. Look into offering
target-maturity portfolios, which change automatically with plan participants over
time. As
participants near retirement age, their money is invested less aggressively
with less risk than when they are further out from retirement and can withstand
more severe market fluctuations. More than 50 percent of the plans surveyed by
Hewitt used this type of arrangement as the default.
2. Think strategically
about where to set the default rate. The Profit Sharing/401(k) Council of
nonprofit association reports that most employers set the default rate at 3
percent, with about 45 percent investing in stable value funds, such as
high-quality bonds, and about 20 percent putting the money into money-market
funds and balanced stock/bond funds. Also keep in mind that the default does
not need to stay at the same rate forever. Nearly 30 percent of the companies
polled in the Hewitt study reported using “contribution escalation” along with automatic
enrollment to boost default contribution rates over time to between 8 and 15
percent.
3. Look for plans that
offer online investment education and resources. Employees can use the online
resources to maximize their savings without having to dig too deep for the
information. According to a study by international financial-services provider Fidelity
Investments, personalized communication and education programs about plan
offerings can dramatically increase workers’ deferrals. The study indicated that
employees who have access to 401(k) enrollment data and their personalized
account information online are more likely to actively review their 401(k)
contributions and make appropriate changes to their elections.
4. Pay attention to fees
associated with plan administration. A recently proposed DOL regulation would require
plan administrators to disclose fees derived directly and indirectly from their
services and to reveal potential conflicts of interest. Plan administration
fees can claim a significant portion of retirement funds over time if employers
are not judicious about the plans they select.