Looking for a way to increase participation in your 401(k) plan? The Automatic Enrollment feature is one way to accomplish this. A typical 401(k) plan allows employees to decide whether or not to enroll in the plan, if so at what percentage and which funds to invest in. A 401(k) plan with the automatic enrollment feature enrolls the employee at their initial date of eligibility, at a default percentage and default investment (if no participant direction is provided). The employee is given the chance to opt out completely or change the amount withheld.
Employers who have adopted this feature say their plan participation has increased from 68% to 77%. This is of special importance for those plans
experiencing discrimination testing problems due to poor participant. As of 2004 15% of 401(k) plans have adopted this feature.
In 1998, the IRS issued a ruling clarifying that automatic enrollment in 401(k) plans is permissible for newly hired employees. In 2000 they stated it was also permissible for current employees who have not already enrolled in the plan. In 2004 the IRS published a general information letter stating that the amount permissible under the plan is up to the annual contribution limits and the plan can automatically increase the employee’s contribution over time.
Surveys report that the most common contribution rate for the automatic enrollment is 3% and these funds are typically invested in a money market fund
or a stable value fund.
A disadvantage to the automatic enrollment to the plan sponsor is the cost to match these 401(k) contributions. By having employees automatically defer, an employer utilizing the plan’s matching contribution provision will naturally have larger amounts of salary deferrals to match.
There is also an issue regarding state laws that require employers to receive written notice from workers before wages are taken out of their paychecks. Depending on the state, this may not be permitted as automatic withholding as it may be considered garnishing.
An additional feature that forces participants to save is the automatic increase of the contribution amount (a.k.a. autopilot). When a plan sponsor implements this feature, the participant’s contributions automatically increase at specific intervals up to a maximum specified in the plan.
The IRS emphasizes that the employees must be fully informed of these plan provisions, and they must be given the option to change the amount of their
contribution or stop contributing to the plan altogether.