Helping Clients Make the Best Auto Enrollment Decisions

Automatic enrollment is not as simple as just deciding to do it and doing it. Several decisions need to be made and some processes need to be discussed before implementation.

According to J.J. McKinney, chief operations officer at Retirement Strategies, Inc. in Augusta, Georgia, plan sponsors must decide who to auto enroll, what the default participant deferral percentage will be, whether to also automatically escalate participant deferrals, what eligibility requirements to use and whether and how much to match participant deferrals. Everyone, including payroll, must understand the logistics, and there should be a discussion about how to roll out automatic enrollment.

For plan advisers, auto enrollment should be somewhere front of mind in plan design discussions with clients that have not adopted it, McKinney says. Following compliance testing is a good time to evaluate whether a client is a good candidate for auto enrollment and to talk about getting more employees to save or to save more.

Plan sponsors with high employee turnover or cost concerns about the financial impact of matching contributions may see automatic enrollment as an unattractive feature, says State Street Global Advisors (SSgA) Global Head of Defined Contribution Fredrik Axsater. But, SSgA is a strong believer in automaticity for all plans.

Axsater explains that in the defined contribution (DC) plan ecosystem there are three pillars: participation, adequate savings and optimal investing. Plans with auto enrollment usually see participation rates north of 90%; automatic enrollment and automatic escalation can ensure participants are saving at rates sufficient to meet their objectives; and with auto enrollment, more participants end up investing in the default investment option, which is usually a better portfolio than they would pick for themselves.

Making the right design decisions can help make auto enrollment work even for plan sponsors with high turnover or cost concerns.

Turnover is important to consider because plan sponsors do not want small balances left to clean up in their plans, McKinney tells PLANADVISER.

According to McKinney, when auto enrollment was making a comeback after passage of the Pension Protection Act, many consultants were recommending plan sponsors automatically enroll participants as of their dates of hire, with the rationale that employees will not get used to a higher amount in their paychecks that suddenly drops when they enter the plan. But, he points out, when you look at the way health benefits are offered, employees usually see a drop in their paychecks once they are eligible, so plan sponsors should think of it in that way.

He says consultants and employers should look at how long people tend to stick around; employers should know that type of information. For example, an employer may notice that once employees pass the 90-day mark, they tend to stay with the company for three years or longer. This is when eligibility requirement decisions will help; perhaps the employer will want to require employees be age 21 and have six months of service before they are automatically enrolled in the retirement plan.

As for matching employee deferrals, automatic enrollment is useful to get employees into the plan when there is no match incentive. But, McKinney argues that a closer look may find employers that think they can’t afford to match deferrals can afford something. Sometimes they don’t know their options, he says, and when they’re asked if they can afford a 100% tax-deductible contribution in any amount and explore the numbers, they may find a small contribution that doesn’t cut much into the bottom line is an affordable incentive. “Even a small match goes a long way in good will,” McKinney states.

Axsater notes that most plan sponsors add auto enrollment only for new participants, but he argues this is not how it needs to be. “We try to challenge clients to think about auto enrolling existing employees, and more now are doing it for the entire population, giving the benefit to all employees. We hope to see more plan sponsors doing so in the future.” It is also a great equalizer across genders, salary levels and age groups, he tells PLANADVISER.

McKinney agrees, saying auto enrollment is an enhanced benefit, not just a plan feature. “If you only do it for new employees, you’re not creating a culture around this. And, you’re adding a plan enhancement, but leaving out 90% of employees. The idea is to get everybody not in the plan or not deferring up to the default percentage to see it’s right to save at that level,” he says.

Plan sponsors should also consider whether they want to auto enroll employees every year. Making people who opt out continue to do so, or bumping up participants who lowered their savings from the default rate, is gaining popularity as employers want to encourage retirement savings, according to McKinney.

Plan sponsors should frame their automatic enrollment decisions with the end goal, Axsater says. Objectives may include helping participants achieve a high income replacement so they can retire when they want to. “Automatic enrollment is one of the most powerful tools to aid participants.”

With this mindset, pieces of the puzzle start falling into place, according to Axsater. For example, if the objective of the DC plan is to supplement a defined benefit (DB) plan, considering the DB benefit and taking into account Social Security helps determine the default level to set for auto enrollment.

Axsater notes that it takes more to retire today than it used to, and if an employee saves 11% over her career, it generates a 44% income replacement. SSgA sees many plan sponsors using a higher default setting and using automatic escalation. The match should also be considered for employees’ total savings, and the default deferral rate should maximize the match.

Discrimination testing issues may also come into play in auto enrollment decisions. It can get complex, but advisers can help plan sponsors, McKinney says. They need to look at the results of average deferral percentage (ADP) testing two or three years before auto enrollment and move the deferral dial up to see what will help them pass the test.

Auto enrolling everyone at 3% may help. But, if that level doesn’t do enough, it still may not have to be a steep progression for the plan sponsor. For example, McKinney says, plan sponsors can look at what they need to do to move up the default for just 70% of those not contributing or not contributing enough to pass the test. That approach also will help in the decision about how to implement auto enroll; to just new employees or re-enrolling all employees.

Decisions about automatic escalation of participant deferrals are going to be part of the logistics discussion, McKinney says. What communications are needed to be able to facilitate auto increase? According to McKinney, different vendors may provide reporting capabilities, but getting auto escalation to work falls more on the plan sponsor and payroll departments.

They need to decide what will work best to have some degree of confidence they won’t miss somebody; should everyone be auto increased at the same time, or should participants be auto increased at their annual anniversary date, for example. And, while plan sponsors can decide what auto escalation cap is right for plan participants, McKinney notes that if plan sponsors can get participants to a combined savings of 15% of pay, including match, participants will have a very good possibility of replacing meaningful income in retirement.