As we work with plan sponsors who are converting to automatic enrollment, we are finding that the individual circumstances of a plan sponsor affect the design of the plan. As a result, we believe that, as the 401(k) community gains experience with automatic enrollment, a variety of automatic plan designs will emerge to cope with specific circumstances.
This article discusses three cases involving our clients. The first is for a company that had a high level of turnover; the second is for a company that had low deferral rates for currently participating employees; and the third is for a company that was worried about the cost of matching contributions.
The High Turnover Case
The first situation involved a client in the retail industry, where turnover rates during the first year are very high. The company was reluctant to convert to automatic enrollment because of a concern about the administrative difficulty and cost of automatically enrolling participants, when many of them will leave within a matter of weeks or months ... resulting in a large number of distributions of small amounts.
In order to obtain the benefits of automatic enrollment for its long-term employees, but to avoid the cost and difficulty of short-term turnover, the eligibility provisions of its plan were designed as follows:
For voluntary enrollment, employees could begin participating on the first of a month following one month of employment.
For automatic enrollment, all employees who had not voluntarily enrolled would be automatically enrolled following one year of employment. (Of course, any automatically enrolled employee could opt out of participation.)
By deferring the automatic enrollment date, the company was able to avoid most of the turnover while, at the same time, allowing concerned employees to voluntarily participate at an earlier date. In addition, the company was able to design a plan that will cover substantially all of its long-term workforce.
As a word of caution, there are unanswered questions about this plan design if a plan sponsor wants to (i) use the safe harbor design, or (ii) to take advantage of the 90-day withdrawal provision or the extended ADP refund provision. However, for regular automatically enrolled plans, the split eligibility periods will work.
Low Levels of Deferrals
In the second situation, a large company in the real estate industry converted to automatic enrollment for all of its employees. In addition, the company wanted to adopt automatic year-to-year increases in deferral rates, so that participating employees would accumulate substantial retirement benefits (sometimes called “step up” or “escalator” deferral increases). However, the company was concerned that many of its long-term participants were deferring at low rates—and perhaps weren’t aware of the need to defer at much higher rates in order to end up with a reasonable level of benefits.
To remedy that situation, the company decided that, for all currently participating employees (as well as for future participants), their deferral rates would increase at 1% per year until they reached 10% of pay.
For example, new employees would be automatically enrolled at 4% of pay and increased 1% per year until they reached 10% of pay. However, if a current participant were already deferring at 5%, that employee’s deferrals would be increased 1% per year, from that point, up to a maximum automatic rate of 10%.
Of course, employees could always opt out of the automatic enrollment and/or the automatic deferral increases. In addition, if employees wanted to defer more than 10% of their pay, they could do so voluntarily.
By the way, a general rule of thumb in the benefits community is that the average employee should be deferring at least 12% of pay in order to have substantial benefits at retirement.
Matching Cost Concerns
In the third situation, the company was concerned about the cost of adopting a safe harbor automatically enrolled plan. That is because the company wanted to use the matching contribution alternative and, if automatic enrollment resulted in a 90% participation rate (which it often does), the contribution cost would be too high. On the other hand, the company wanted the benefit of satisfying the ADP test (or discrimination testing) under the safe harbor.
Our client worked with a consultant to test various plan designs for automatic enrollment. In doing the testing, they realized that, even without the matching contributions required by the safe harbor rules, the ADP test could be satisfied with an automatically enrolled plan. As a result, the plan sponsor was able to pass the ADP test, but without the matching cost of the safe harbor design. The moral to that story is that automatic enrollment, in and of itself, goes a long ways towards satisfying ADP testing.
These cases illustrate that automatic enrollment is not a “one trick pony.” It is a versatile tool that, in the hands of knowledgeable advisers, can produce a plan design that is good for employees, affordable for the plan sponsor, and compliant with legal standards.