Did you know that in European countries such as Austria and Sweden, the rate of people who agree to donate their organs is remarkably high (well above 90 percent)? By comparison, in neighboring countries such as Germany and Denmark, the donation rate is in the teens. Why is there such a wide disparity? Residents of countries with high donor rates are asked to opt out of donation instead of opting in when they fill out their driver’s license form. In other words, they’re asked to check a box if they don’t want to donate their organs, rather than being asked to check a box if they do want to donate their organs. The opt-out option is an astoundingly minor lever that, when pulled, creates a hugely impactful action.
The role played by workplace retirement plans, such as 401(k) or 403(b) plans, in helping working Americans save for retirement can’t be understated. In fact, eye-opening research indicates 56 percent of those who participate in a defined contribution plan say they probably wouldn’t save for retirement if they didn’t have a plan at work. Although having access to a retirement plan is a great starting point, it’s simply the gateway to achieving retirement readiness. More can—and should—be done to nudge employees to save more in their retirement plans. Fortunately, there is a wildly easy and effective way to get retirement plan participants to begin saving (or saving more): retirement plan automatic features.
Retirement plan auto features, such as auto enrollment, auto-deferral escalation, and reenrollment, have become an effective and popular way for retirement plan sponsors to improve retirement saving outcomes of their valued employees. Auto features help support foundational principles that can result in successful participant outcomes by:
Lowering psychological barriers that might prevent participants from enrolling in their company’s retirement plan and getting them to save earlier in their work life cycles
Helping them overcome the inertia that often keeps savings rates static, thrusting their savings momentum forward
Providing opportunities to invest in funds that offer more appropriate asset allocations
Let’s look at how these auto features work, the benefits for plan participants and your plan sponsor clients, and why the manner in which they are implemented matters.
Although auto enrollment was introduced long ago, its popularity continues to rise, with 69 percent of retirement plans offering an auto-enrollment feature, compared with 51 percent in 2015.
How it works. With auto enrollment, eligible employees are automatically set up to contribute to the retirement plan at a specific percentage of pay. The most common default percentage is 3 percent, according to research from Deloitte. There’s an opt-out feature, but—good news—only 10 percent of employees choose not to enroll.
It’s important to stress to your plan sponsor clients that after implementing an auto-enrollment feature, the vast majority of plan participants stay enrolled in the plan. In fact, T. Rowe Price found 85 percent of participants stayed in their 401(k) plans after being automatically enrolled. That’s compared with a 44 percent participation rate for plans with voluntary enrollment (which requires employees to opt in). If your plan sponsor clients are skittish about employee pushback, you can ease their concerns. Employers who have implemented an auto-enrollment feature say employee resistance has been less than anticipated, according to the Plan Sponsor Council of America’s 62nd Annual Survey of Profit Sharing and 401(k) Plans.
Benefits. Beyond the obvious benefits to participants, automatic enrollment has many benefits for your plan sponsor clients, including:
Increased participation and higher contribution rates. These factors may favorably affect a sponsor’s nondiscrimination testing results, allowing owners and highly compensated employees to contribute more to their retirement savings plan.
Streamlined and standardized onboarding process for new employees.
Simplified selection of appropriate investments, particularly target-date fund investments. This often fulfills Qualified Default Investment Alternative (QDIA) objectives, providing safe harbor protections for plan fiduciaries.
Encouragement for employees on the path to retirement. This can help stave off the drag on a business’s financial resources when employees can’t afford to retire, as well as foster a culture of loyalty, morale, and productivity.
Potential to qualify for a tax credit of up to $500 for three years, courtesy of a provision in the SECURE Act.
Automatic Deferral Escalation
A logical next step for implementation is auto-deferral escalation. This tried-and-true feature helps plan participants incrementally bump their contribution rates until they meet a predetermined level. The minimum recommended ceiling is 10 percent.
How it works. Auto-deferral escalation features allow plan sponsors to set the percentage by which a participant’s elective deferral will increase each year until it reaches a predetermined ceiling. The most common annual increment is 1 percent.
Benefits. Notably, auto-deferral escalation combats the inertia retirement savers regularly grapple with, causing them to leave their savings rates static—a major error. Again, the effect of opt out versus opt in with respect to auto-deferral escalation can’t be underestimated. According to T. Rowe Price, participants presented with an opt out for auto-deferral escalation adopt at a rate of 65 percent, compared with an adoption rate of just 12 percent for those presented with a choice to opt in. Furthermore, increasing deferral percentages encourages participants to realize the full extent of their employer-matching contribution possibilities—no more leaving free money on the table!
Adding a reenrollment feature essentially gives participants a chance at a do-over. It allows them to modify their existing (and, in many cases, unsuitable) 401(k) investment choices into the plan’s QDIA (typically a target-date fund). Unfortunately, reenrollment has seen only a 9 percent adoption rate by plan sponsors. Yet, only 34 percent of plan participants are highly confident in selecting plan investments, and more than 60 percent admit to preferring investment help.
How it works. Participants receive a notification that their existing assets, as well as future contributions, will be directed to the QDIA on a specified date, unless they choose to opt out. As is the case with other auto features, reenrollment opt-out rates are surprisingly low. For participants who aren’t confident enough to choose investments or lack the time and discipline to stay on top of their investments, reenrollment is a great way for them to hit the reset button and ensure that they’re repositioned to meet their retirement goals.
Benefits. When implemented correctly, reenrollment allows plan sponsors to strengthen their fiduciary standing by gaining favorable QDIA safe harbor protections.
What’s Your Role?
As an advisor to plan sponsor clients, you can take three steps to help your clients pull the right levers and take full advantage of the benefits of auto features.
1) Review your book of business. Start by reviewing your book of business to identify plans that aren’t currently adopting auto features. All employers could benefit from auto features in their company’s retirement plan, but to begin, pay particular attention to those that display the following warning signs:
Low or historically declining participation rates, counting eligible versus participating employees with an account balance
Low or historically declining savings rates (the average participant savings rate is 7 percent, according to Vanguard research)
Low average account balances for participants (the average balance is $106,478, according to Vanguard research)
Plans recently needing to make corrective distributions (This occurs when nondiscrimination testing is failed. As a result, highly compensated employees have a portion of their elective deferrals returned. Corrective distributions are an indication that eligible rank-and-file employees are not participating or deferring enough, which can negatively affect nondiscrimination testing results.)
Companies with multiple locations, which typically have enrollment and engagement challenges
Lack of QDIA or target-date funds in the plan offering
2) Talking points for clients. Present the various retirement plan auto features to clients who display the warning signs. Remind them how a retirement plan benefit can be a key factor when trying to attract and retain talented employees, and discuss how these features can help them and their employees. Other talking points to consider include:
Auto enrollment: As mentioned, the standard auto-enrollment rate is 3 percent. For new adopters of auto enrollment, this might be a palatable starting point. For clients whose plans have already adopted this feature, suggest bumping the default rate up to a more aggressive 6 percent.
Auto-deferral escalation: Consider using a higher annual increase rate of 2 percent instead of 1 percent. As auto-deferral escalation ceiling rates climb, you can encourage clients to aim higher with the annual increase cap amount, setting it at 10–15 percent.
Reenrollment: Discuss the appropriateness of the plan’s QDIA, with respect to the plan goals and objectives, and emphasize the importance of reviewing it periodically using a documented process.
3) Reach out to service providers. Finally, be sure to discuss auto features with your clients’ service providers, such as their recordkeeper and third-party administrator, to determine whether the features are feasible and what, if any, effect they might have on the employer’s annual nondiscrimination testing and matching contribution budgets.
Open the Lines of Communication
Here are tips to create an effective and thorough plan for communicating changes to employees:
Be sure to get buy-in from the plan sponsor’s human resources department and other key stakeholders, so they become program advocates and can help address employee apprehensions.
Opt-out mechanisms are a proven game changer. As such, a strong communications program is vital. This will help ensure that participants aren’t surprised by actions taken on their behalf. These communications are also an opportunity to explain why the plan is adopting auto features and how the changes will help plan participants meet their retirement income goals, as well as prepare for potential objections (which, as discussed above, should be minimal).
Provide context for participants and ensure that they are educated about their options, the importance of saving for retirement, and the tremendous opportunity they are being given to prepare for their financial futures.
Of course, there is no universal solution to foster retirement plan engagement, but as evidenced by research, giving retirement savers a nudge to take action for their financial futures is well worth the effort. Proactively offering simple auto-feature solutions that can optimize your clients’ retirement plan offerings will have a meaningful effect on employers and employees alike.
Editor’s note: This post was originally published in July 2019, but we’ve updated it to bring you more relevant and timely information.
This material is for educational purposes only and is not intended to provide specific advice.