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Consider Automatically Enrolling Employees In Your 401(k) To Make Your Plan Less Burdensome

A 401(k) plan can be great for both employees and employers. As an employee, you get to stash away money in your retirement account that may be supplemented by matching contributions from your company. Your investments generally grow undisturbed by taxes until you make withdrawals during retirement.

For employers, funding a 401(k) plan normally costs less than a traditional pension or profit-sharing plan. It can also be an effective way to attract and retain valuable employees. So everyone wins.

But there’s a catch. Plans such as 401(k)s are subject to strict non-discrimination testing to make sure that highly compensated employees—HCEs, in tax lingo—aren’t reaping an unfairly large share of plan benefits. Fortunately, there’s a relatively simple solution. Your company can use an automatic-enrollment plan designed to encourage a higher level of participation. Rule changes mandated by the Pension Protection Act of 2006 make this easier.

Traditionally, employees have had to decide to join a 401(k) plan. With automatic enrollment, however, they’re in the plan unless they opt out.

The virtue of auto-enrollment is that most people, including lower-paid workers, tend not to opt out. Typically, 3% of each participating employee’s compensation may be directed into that worker’s plan. There are also default investment options, normally mutual funds, that will be used unless an employee chooses other investments. So a participant needn’t lift a finger to join the plan and get invested.

If you want to add this provision to your 401(k), a plan provider, third-party administrator, or consultant can help you revise your plan documents. Meanwhile, the Pension Protection Act, or PPA, makes it easier for employers to implement auto-enrollment. For example:

• Federal law preempts state laws that could interfere with an auto-enrollment plan.
• It facilitates fulfillment of one aspect of the employer’s fiduciary responsibilities—that is, their legal obligation to act in an employee’s best interests—if an employee’s contributions are invested in the plan’s qualified default investments.
• If a plan fails nondiscrimination testing, it has six months after the close of the plan year to make “corrective distributions” (instead of 2½ months under old rules).
• For the purpose of establishing eligibility, the plan may exclude employees already in the plan or who have opted out.
• Employer contributions to the plan are vested after two years of service.
  

  One caveat: Employers should be sure to select the right default investment option and that employees are educated about it. This could limit any potential liability if a worker argues in the future that he was placed automatically in the default investment without understanding it and that it was inappropriate for him.
  

  Adding an auto-enrollment feature to your company retirement plan nudges lower-paid workers into saving for retirement. This can benefit employees and business owners in the long run. Adding automatic enrollment to your company’s plan and fulfilling your fiduciary responsibilities is a serious matter, and we are always here to answer any questions you may have on this topic.