Does Your 401(k) Plan Have PB&J, Or Is It Just Dry Toast?

Wednesday, December 16, 2020

Jim Sampson, Business Contributor

 

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To drive plan participation, 69% of companies use an auto-enroll feature with their 401(k)s. This essentially allows the employer to enroll eligible employees unless they affirmatively elect not to participate. It can be a great way to increase participation in your company’s retirement plan. However, there are pitfalls to avoid.

In some situations, employees’ wages would be reduced by the plan’s default contribution percentage, sometimes as low as 2% or 3%. A potential issue is that the default deferral rates could cause employees to contribute less than they would if they actively signed up for a plan on their own. That’s because many employees who are auto-enrolled leave their savings rate at the low initial percentage. Over time, that means less for workers’ total retirement savings.

In some ways, enrolling someone at 3% and leaving them at that rate could actually do more of a disservice than not enrolling them at all because it conveys the message that 3% is enough. And we all know that it isn’t. That’s where auto-increase (or auto-escalation) comes in.  Auto-increase and auto-escalation are like peanut butter and jelly – they just go better together.

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A more effective plan design would be to auto-enroll employees at a more meaningful number, such as 5% or 6%, as industry data shows that the opt-out rate is no different when enrolling employees at 6% versus enrolling them at 3%. Increasing the savings amount by 1% each year will help employees get into the range of 10% to 15% over time, allowing them to have a greater chance at “retirement dignity,” or the ability to retire on time and with enough money.

Adoption of auto features have been on the rise the last 10 years, especially in the large plan market, and those numbers are also growing among smaller plans. Using auto-enroll with auto-increase is the closest way to replicate the old pension plan scenario in which the company paid into the plan, managed investments, and paid out benefits at retirement. By streamlining contributions to employees’ accounts, increasing the amount they save over time, and having a default investment option built in, the employee doesn’t need to think about saving if they don’t want to.

Employers can now benefit financially from using these features as well. The December 2019 passing of the SECURE Act included a $500 direct tax credit for companies that add auto-enroll to their plans. Auto features can also be used to achieve Safe-Harbor, allowing companies to waive certain discrimination tests and eliminate refunds to employees.

Employees can always opt out of either feature if they choose. But using the combination of both auto-enroll and auto-increase puts employees in a better position to succeed.  This can go a long way to boosting satisfaction and productivity in the workplace.  Some might even call it the greatest thing since sliced bread.

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Jim Sampson is the Director of Retirement Advisory Services at Hilb Group Retirement Services in Warwick, supporting retirement plans for companies and their employees for the last 24 years, and is the co-author of the book Save Like a Champion Today, A Winning Game Plan for Retirement.

Investment Advisory services offered through Global Retirement Services (GRP), DBA Hilb Group Retirement Services, a registered investment advisor.

 

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