Today’s workforce relies primarily on defined contribution plans as a means for saving for retirement. Although employee contribution rates and account balances are up, participants tend to defer only enough to receive their company match—and that might not be a high enough savings rate to meet their retirement income goals.
Over the past several years, implementing retirement plan auto features has become an effective and increasingly popular way for plan sponsors to help improve retirement plan outcomes. The most common features include auto-enrollment, auto-escalation, and re-enrollment. Auto features help support the basic principles that can result in better participant outcomes:
- Participating and saving earlier
- Increasing savings levels
- Providing access to appropriate asset allocations
Let’s take a closer look at how specific auto features work, plus their benefits for plan participants, employers, and your plan sponsor clients.
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Automatic enrollment grew out of the Pension Protection Act of 2006, and it’s a great way for employers to help their workers get a head start on saving for retirement. According to 2018 data from T. Rowe Price, 79 percent of plans have now adopted auto-enrollment, compared with 69 percent in 2015.
How it works. With auto-enrollment, employees are set up to contribute to the retirement plan at a specific percentage of pay. Most plans also permit employees to change that percentage to one with which they’re more comfortable. Employees should always have the ability to opt out of auto-enrollment before any contributions are deducted from their pay.
It’s important to stress to plan sponsors that after implementing an auto-enrollment feature, the vast majority of plan participants will stay enrolled in the savings plan. In fact, T. Rowe Price found that 86 percent of participants stayed in their 401(k) plans after being automatically enrolled, compared with a 44 percent participation rate for plans with voluntary enrollment.
Benefits. Automatic enrollment has many benefits for your plan sponsor clients, including:
- Assured increase in plan participation
- Increased number of participants and contributions, which may allow owners and highly compensated employees to contribute more to their retirement savings plan
- Streamlined and standardized onboarding process for new employees
- Simplified compliance efforts, depending on safe harbor and other sponsor choices
- Allowance for salary deferrals into specific investment options if employees do not make their own choices
- Simplified selection of investments appropriate for participants
Automatic Contribution Escalation
Another popular auto-feature, automatic contribution escalation, can help plan participants slowly and consistently increase their contribution rates until they meet a predetermined level. This feature is growing in usage, with about 66 percent of plans with auto-enrollment also using auto-escalation, according to Vanguard.
How it works. Auto-escalation features allow plan sponsors to choose any initial default contribution rate for their automatic contribution-escalation programs. While most plans adopt a 1 percent annual increase, there is no requirement to use that amount. Plan sponsors are free to use a higher step-up percentage or to step up the rate on a more or less frequent basis.
Benefits. This feature helps employees reach a healthy savings rate (e.g., 10 percent to 15 percent) earlier in their careers and puts them in a better position to retire at a “normal” retirement age. When older employees are able to retire on time, employers may benefit in the following ways:
- Lower health care costs: Insurance costs for an older workforce are higher than for a younger workforce.
- Lower salary costs: Typically, older employees earn higher salaries than do their younger counterparts.
- Greater engagement: Often, older workers are less engaged compared with younger employees who are trying to grow in their careers.
Last, but not least, re-enrollment is an extension of the auto-enrollment feature put in place for new hires. It gives the plan the ability to expand the existing choice-architecture benefit to all employees, while allowing them to opt out or invest on their own.
How it works. Participants are placed automatically in an age-appropriate qualified default investment alternative (QDIA) that is typically professionally managed. According to a Callan survey, by far, the biggest reason for re-enrollment in 2018 was changes in the fund lineup. For those participants who don’t regularly review their investment options, re-enrollment is a great way to hit the reset button to ensure that they are appropriately invested and in a better position to meet their retirement goals.
Benefits. When implemented correctly, re-enrollment allows plan sponsors to strengthen their fiduciary standing by gaining sought-after safe harbor protections through the Pension Protection Act.
What’s Your Role?
As an advisor to plan sponsor clients, it’s important to ensure that the plans you work with are taking full advantage of the benefits auto features can provide. Start by reviewing your book of business to identify plans that aren’t currently adopting auto features, paying particular attention to those that are struggling with the following:
- Low participation rates (eligible versus participating with account balance)
- Low savings rates
- Plans with corrective distributions (could be a signal that not enough of the non-highly compensated are contributing)
- Multiple locations (typically have enrollment and engagement challenges)
- No QDIAs or QDIAs used incorrectly
Next, explore the various retirement plan auto features with those clients, and discuss how these features can help optimize their plans:
- Auto-enrollment: Consider a 6 percent default contribution rate rather than the typical 3 percent.
- Auto-escalation: Consider using a higher annual increase rate of 2 percent rather than 1 percent. You might also aim higher with the annual increase cap amount, setting it between 10 percent and 15 percent.
- Re-enrollment: 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.
Finally, be sure to discuss auto features with recordkeeping partners and third-party administrators to determine whether they are feasible and what, if any, effect they might have on plan testing.
Developing a Participant Communication Plan
An effective and thorough plan for communicating changes to employees is critical to success.
- Be sure to get buy-in from the plan sponsor’s human resources department and other senior managers, so they become program advocates and can help address any employee questions or concerns.
- A strong opt-out 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 communicate the rationale for why the plan is being changed and how the changes will help plan participants meet their retirement income goals.
- Try to ensure that it is easy for any eligible participants to opt out of any retirement plan auto features. Plan sponsors will need to remind eligible employee segments and supplement the outreach with educational meetings to help employees understand the plan changes and actions they can take.
Of course, there is no universal solution to foster retirement plan engagement. But by identifying opportunities where auto features could improve plan optimization, you will be well prepared for meaningful conversations with your plan sponsor clients and prospects.
What percentage of the retirement plans you work with have adopted auto features? How do you communicate the benefits of these features to those who are still missing out? Please share your thoughts below!
Editor’s Note: This post was originally published in May 2016, but we’ve updated it to bring you more relevant and timely information.