Pensions and retirement benefits: Now is the time to think about automatic enrollment for 2011

published in Oklahoma Employment Law Letter | August 1, 2010

By Brandon P. Long

The only retirement savings vehicle most employees have is their company’s 401(k) plan. Yet many employees fail to save at all. According to one 2010 survey, only 16 percent of workers are “very confident” they will be able to live comfortably when they retire. Even more troubling, the same survey revealed that only 29 percent of workers are “very confident” they will be able to cover basic expenses when they retire.

Make inertia work to your employees’ advantage

Employers can take advantage of their employees’ inertia while helping them save for retirement by adding an automatic enrollment feature to their 401(k) plan. With automatic enrollment, employees are automatically enrolled at a percentage of their compensation (for example, 3% of compensation) unless they specifically opt out or elect a different percentage. The automatic deferral percentage may or may not increase on an annual basis.

Studies have shown, and numerous commentators have recognized, that automatic enrollment can be an effective way to encourage employees to save for retirement. In fact, recent surveys show that participation rates for many employers went from under 20 percent to over 80 percent after implementation of automatic enrollment. It especially helps lower- and moderate-income workers, but employees at all income levels start to save earlier, save more, and have better investment choices than similar plans without the mechanism.

Automatic enrollment can also provide certain benefits to employers. For example, it may help you pass 401(k) nondiscrimination testing by either satisfying certain safe-harbor requirements or merely boosting 401(k) plan participation or contribution rates among employees who aren’t highly compensated.

Also, depending on how the automatic enrollment arrangement is structured, you could gain additional time (six months after the end of the plan year as opposed to two and a half months) to distribute excess 401(k) deferrals and/or excess matching contributions to highly compensated employees. That’s particularly important when the plan has failed its actual deferral percentage and/or actual contribution percentage test. While most large employers are familiar with automatic enrollment in 401(k) plans, the majority of companies have yet to adopt it despite the obvious advantages.

There are several types of automatic enrollment arrangements. One popular type is an eligible automatic contribution arrangement (EACA). An EACA is an arrangement within a 401(k) plan (or certain other types of deferral plans) under which:

  1. an eligible employee can elect to have the employer make payments on his behalf as deferrals under the plan or receive cash payments directly; and
  2. the employee is treated as having elected to have the employer make contributions to the plan in an amount equal to a uniform percentage (e.g., 3%) of compensation until the employee specifically elects not to have contributions made (or specifically elects to have contributions made at a different percentage).

In addition, an EACA satisfies certain initial and annual notice requirements. Perhaps the key feature of an EACA is that it is permitted, but not required, to give employees a 90-day window to withdraw or “unwind” money that has been automatically deferred into the plan. Provided the withdrawal of the automatic deferrals occurs within the 90-day window (any related matching contributions must be forfeited), the withdrawal isn’t subject to the 10 percent early withdrawal penalty and doesn’t violate the Internal Revenue Code restrictions on distributions.

The rules governing automatic enrollment arrangements require that certain notices be provided to employees. For example, an EACA requires that notice be given (1) before an employee is first subject to automatic enrollment and (2) on an annual basis afterward. Each EACA notice must explain:

  1. the level (that is, the specified percentage) of deferrals that will be made on the eligible employee’s behalf if the employee doesn’t make an affirmative election to defer;
  2. the employee’s right to elect not to have automatic contributions made on his behalf (or to elect to have deferrals made at a different percentage or amount);
  3. how the automatic contributions made on the employee’s behalf will be invested in the absence of the employee’s investment election; and
  4. if applicable, the employee’s right to make a 90-day withdrawal and the procedures for electing the withdrawal.

Act now for 2011

Given the annual notice requirement associated with certain automatic enrollment arrangements (e.g., EACAs) and that certain automatic enrollment arrangements must be started and maintained on a plan-year basis, if you have considered or are considering adding automatic enrollment in 2011, you may have a December 1, 2010, notice deadline approaching. Thus, now is the time to talk with your benefits advisor about your options. Be sure to ask about:

  • the types of arrangements available (including EACAs);
  • whether you want the arrangement to apply to new hires only or to all employees without an affirmative election (and why you might want it to apply to all employees);
  • the advantages and legal issues surrounding an annual increase of the automatic deferral percentage;
  • notice deadlines; and
  • options for investing automatic deferrals (in the absence of affirmative direction from the employee).