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Automatic 401(k) Enrollment: Right for Your Company?

 

Traditionally, employees have to opt in to retirement plans and make their own decisions about contributions. But there's another possibility: automatic enrollment. If they choose to enroll their staff automatically, companies have three options:

Basic automatic enrollment, also called an "Automatic Contribution Arrangement” (ACA)

  • Employees are automatically enrolled in the 401(k) plan unless they choose otherwise.
  • The plan document states the default percentage that will be automatically deducted from employees' wages.
  • Employees can choose to opt out or to contribute a different amount from the default percentage.

Eligible automatic contribution arrangement (EACA)

  • This arrangement is similar to the ACA, except that it has specific notice requirements and permits auto-enrolled employees to withdraw their automatic contributions, plus earnings, within 30-90 days of making their first automatic contribution.

Qualified automatic contribution arrangement (QACA)

  • Along with having notice requirements, the QACA specifies employer contribution amounts, a vesting schedule based on years of service and the default percentage for automatic enrollment.
  • Employees can choose to opt out or to contribute a different amount from the default percentage.

Other key provisions

Whichever option your company chooses, it may include one of the following options:

Default Investments: The employer can select a default investment option for auto-enrolled employees who do not elect their own investments. These employees must be given an opportunity to change the investment choice.

Automatic Escalation: With automatic escalation, you automatically increase employees' 401(k) contributions over a period of time. For instance, you might increase employees' contributions by 1% annually, up to a maximum of 15% — or more, if the employee elects a higher amount.

Default rates: Traditionally, employers who auto-enroll employees defer 3% of each employee's salary to his or her plan. However, more and more employers are auto-enrolling at higher rates, such as 5% or 6% of the employee's pay. Studies show that most employees support a 6% automatic contribution rate and want their employers to automatically increase their contributions each year. 

Employers should be aware of any legal limits on automatic enrollment or escalation. For example, the Setting Every Community Up for Retirement Enhancement (SECURE) Act raises the deferral cap for automatic enrollment safe harbor plans from 10% to 15%.

Advantages of automatic enrollment

According to the Department of Labor, automatic enrollment:

  • Helps you find and keep qualified people.
  • Boosts plan participation rates among all employees, including management.
  • Encourages employees to start saving for retirement.
  • Allows participants to make salary deferrals even if they do not choose their own investments.
  • Delivers tax savings when employers and employees make pretax contributions.

In addition, the SECURE Act provides a tax credit to eligible employers who add an automatic enrollment feature to their 401(k) plan.

How to set up an automatic enrollment 401(k) plan

  • Decide on what type of automatic enrollment plan you want to offer.
  • Create a written plan document.
  • Select a trustee to safeguard the plan's assets.
  • Develop a recordkeeping system for 401(k) transactions and expenses.
  • Give your employees the necessary 401(k) and automatic enrollment notices.

Currently, automatic enrollment is voluntary for employers. But keep an eye out for federal legislation that might require employers to automatically enroll eligible employees in the company's 401(k) plan.

Of course, this is just an introduction to a complex topic. Retirement plans are heavily regulated, and rules change, so make sure you work with a professional to ensure you are in compliance with the latest laws.

 
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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