Automatic Enrollment – Is It Right for Your Small Business 401(k) Plan?
Last year, we studied the plan designs of 2,767 small business 401(k) plans that averaged approximately 25 participants and $1M in assets. We found only 8.71% of these plans automatically enroll eligible employees who fail to make their own affirmative enrollment election. In contrast, a 2014 Willis Towers Watson study found 68% of 457 larger 401(k) plans include an automatic enrollment feature.
Automatic enrollment is widely regarded as a powerful tool for spurring retirement savings, so it can surprise people to learn that small 401(k) plans adopt the feature at much lower rates than larger plans. However, there is a simple explanation for this difference – small 401(k) plans are more likely to be safe harbor. While our study found 68% of small 401(k) plans are safe harbor, a 2012 PSCA study found that percentage drops to 34% for larger plans. Due to their generous employer contributions, safe harbor 401(k) plans rarely have a problem with employee participation – making automatic enrollment unnecessary.
While automatic enrollment can be a great tool for a 401(k) plan to increase employee participation, plans that don’t need the help should avoid the feature. That’s because it adds annual administration responsibilities that can be expensive to fix if done improperly. If you’re considering automatic enrollment for your 401(k) plan, you’ll want to understand these requirements to determine whether feature’s benefits will make them worthwhile.
What are the different automatic enrollment types?
There are three basic types of automatic enrollment arrangements, each with different features and requirements.
*A QACA is a type of safe harbor 401(k) plan. Because they include an automatic enrollment feature, these safe harbor plans are permitted to offer a less costly match (3.5% instead of 4%) and a longer vesting schedule (2-year cliff instead of immediate) than traditional safe harbor plans.
The additional administration
An automatic enrollment feature adds 2 major administration responsibilities to a 401(k) plan: 1) distributing a notice that describes the feature – which participants must receive before they become plan-eligible and then annually before the start of each new plan year – and 2) enrolling participants that fail to make their own affirmative enrollment election by default.
If a 401(k) plan’s automatic enrollment feature includes an escalating default rate (commonly called an “escalator”), the employer must also remember to increase the default deferral rate for automatically enrolled participants each year.
These additional requirements are not particularly onerous, but making a mistake can take a lot of effort to correct.
The consequences for making mistakes
The consequences for failing to automatically enroll a new 401(k) plan participant, or automatically escalate an existing participant’s deferral rate, depends upon when the participant’s deferral rate is corrected.
- When the employer corrects the deferral rate no later than the earlier of 1) 9 ½ months following the close of the plan year in which the mistake occurred or 2) the last day of the month following the month in which the participant advises the sponsor of the problem, they have no obligation to fund a Qualified NonElective Contribution (QNEC) to the affected participant’s account to correct their “missed deferral opportunity.”
- When the correction is made later, but not later than the last day of the second year following the plan year in which the mistake occurred, the employer must fund a QNEC equal to 25% of their missed deferral opportunity.
- For corrections made later still, the QNEC amount increases from 25% to 50% of the missed deferral opportunity.
Regardless of when an automatic enrollment mistake is corrected, an employer must also do the following to complete the correction:
- Make the matching contribution that the participant would have received had the mistake not occurred.
- Provide a notice to the affected participant(s) within 45 days of the date of the deferral fix describing the issue.
- Allocate lost earnings.
Do you really need it?
No employer gets style points for administering 401(k) features they don’t need. While automatic enrollment can be a powerful tool for increasing employee participation in a 401(k) plan, not all plans need the help – especially safe harbor plans.
If your plan doesn’t have trouble with employee participation, you want to avoid automatic enrollment. The feature adds administration that can be expensive to fix when mistakes are made.
About Eric Droblyen
Eric Droblyen began his career as an ERISA compliance specialist with Charles Schwab in the mid-1990s. His keen grasp on 401k plan administration and compliance matters has made Eric a sought after speaker. He has delivered presentations at a number of events, including the American Society of Pension Professionals and Actuaries (ASPPA) Annual Conference. As President and CEO of Employee Fiduciary, Eric is responsible for all aspects of the company’s operations and service delivery.