More and more plan sponsors are embracing auto enrollment into defined contribution (DC) retirement plans as a way to solve their participation and testing challenges, but sponsors are often unaware that auto enrollment can also create very serious issues.
Auto enrollment is the process of starting deferrals for eligible employees at a set rate unless the employee actively elects out of the program. On the shiny side of the automatic enrollment coin are the positive effects. It can be a great solution for increasing participation rates, helping to improve retirement outcomes as many participants tend to stick with the default contribution rate and thus do actually end up saving more money, and it can improve discrimination testing results because of the increased participation.
But, as with all shiny coins, there is a flip side to auto enrollment that is often overlooked. Failure to perfectly administer auto enrollment provisions can be costly for a plan sponsor.
The two most common failures for auto enrollment plans are: 1) failure to notify employees of the plan provision, and 2) failure to enact the auto enrollment and withhold deferrals on a timely basis, or at all. These failures nearly always result from bad data—incorrect date of hire on a payroll file, for example, a miscoded rehire, or a keying error when entering deferral changes into a payroll system. The possibilities are numerous and the corrections can be costly.
In general, the Internal Revenue Service (IRS) has prescribed corrective action for missed deferrals with less than nine months remaining in the year, requiring the plan sponsor to deposit:
- 50% of missed deferrals
- 100% of missed match
- Earnings at a reasonable interest rate
Consider the scenario shown in Figure 1 of missed deferrals that are due to failure to start the withholding on a timely basis, for a client with a 4% auto enrollment rate and a match formula of 100% up to a maximum of 6% deferred.
Figure 1: Client’s annual payroll data
| Employee | Monthly compensation | Correct auto enroll begin date | Actual deferral begin date | Missed months of deferral |
| Amber A | $6,666.67 | 1/1 | 12/1 | 12 |
| Bob B | $3,333.33 | 4/1 | 12/1 | 8 |
| Carol C | $5,416.67 | 7/1 | 12/1 | 5 |
| Doug D | $2,083.33 | 10/1 | 12/1 | 2 |
Correction calculation*:
| Employee | Missed deferrals | 50% of missed deferrals | 100% of missed match | Plan rate of return | Total correction |
| Amber A | $3,200.00 | $1,600.00 | $3,200.00 | 8% | $5,184.00 |
| Bob B | $1,066.67 | $533.33 | $1,066.67 | 8% | $1,728.00 |
| Carol C | $1,083.33 | $541.67 | $1,083.33 | 8% | $1,755.00 |
| Doug D | $166.67 | $83.33 | $166.67 | 8% | $270.00 |
| $8,937.00 |
*In this scenario all missed deferrals were started when the error was uncovered December 1.
The full correction of $8,937.00 is funded by the employer (not the employee) in the form of a qualified non-elective contribution (QNEC). That means the money is 100% vested immediately and does not count against the 402(g) limit for the participant. Most plan sponsors will choose to communicate the specifics about these corrections via correspondence letters to the affected participants and should be prepared to field an array of resulting questions.
Another popular automatic feature is auto escalation. Auto escalation is the process that continues to increase a defaulted deferral rate annually up to a set limit. For example, auto enrollment could be set up to begin deferrals at 4% and increase 1% every year up to 10% unless the employee opts out of the program.
The common failures for auto escalation are again data-driven. They usually result from failure to recognize an employee as part of the default program and therefore failure to properly escalate the deferral. The corrections tend to be smaller because the increased rate is typically 1%, but if the problem is widespread in the plan it can add up quickly.
Consider the scenario shown in Figure 2 of missed deferrals that are due to failure to increase the default contribution rate.
Figure 2: Annual payroll data for a client with annual anniversary date increases
| Employee | Monthly compensation | Correct deferral increase begin date | Actual deferral increase begin date | Missed months of deferral |
| Amber A | $6,666.67 | 1/1 | 12/1 | 12 |
| Bob B | $3,333.33 | 4/1 | 12/1 | 8 |
| Carol C | $5,416.67 | 7/1 | 12/1 | 5 |
| Doug D | $2,083.33 | 10/1 | 12/1 | 2 |
Correction calculation*:
| Employee | Missed deferrals (1%) | 50% of missed deferrals | 100% of missed match | Plan rate of return | Total correction |
| Amber A | $800.00 | $400.00 | $800.00 | 8% | $1,296.00 |
| Bob B | $266.67 | $133.33 | $266.67 | 8% | $432.00 |
| Carol C | $270.83 | $135.42 | $270.83 | 8% | $438.75 |
| Doug D | $41.67 | $20.83 | $41.67 | 8% | $67.50 |
| $2,234.25 |
*Rates were to escalate from the original 4% default to 5%, match rate is 100% up to 6%.
Again, this correction of $2,234.25 is funded by the employer (not the employee) in the form of a QNEC and will not count against the 402(g) limit for the employee.
It can even go one step further. There is also a design option that makes employees opt out of the increase every year if they are not at the minimum (10% in the above example). This can be cumbersome to administer and frustrating for employees as every year the plan sponsor determines the population and those employees have to again opt out of the default program.
Now consider that you are creating small balances in your retirement plan. There will be a population of employees who let the auto enrollment happen, and then one month, six months, or 12 months down the road decide they really don’t want to contribute and they stop the deferral. The plan is left with a small account balance until the employee leaves the company and takes a payout. This can have a negative impact in the following ways:
- Fees: Some administrative costs may be based on the number of participants with a balance in the plan. This cost goes up even when a participant holds an account with a small balance. Typically, when fees are assessed to a plan they are allocated to participants in a pro rata fashion based on account balances. So a person with a $25 balance will add to the cost but share in very little of the administrative costs shouldered by the plan.
- Printing and postage: One of the larger underlying costs in plans is the cost for printing and postage. Every person in a plan, no matter how large or small a balance, can expect to receive four quarterly statements each year along with other annually required notices. While a plan sponsor may try to deliver as much as possible electronically, there are still notices that must be delivered via hard-copy mail. This cost for small balances can add up.
- Lost participants: Once an employee has left a company it is up to the employee to notify the recordkeeper of any new addresses. However, when that doesn’t happen it is up to the plan sponsor to search out a good address for the former employee before a payout can be processed. Until then, the small balance will remain in the plan.
Tracking auto enrollment and auto escalation and finding lost participants is often something a plan sponsor will expect a recordkeeping system and their third-party administrator to handle. While most recordkeeping systems are designed with some auto features in mind, not every situation can be accommodated in an automated fashion. Remember, data issues tend to be the source of errors over automated system processing.
Even with stellar recordkeeping in place, things can go wrong with systems, data, and the people involved. As illustrated above, the corrections can quickly add up. It is important that plan sponsors understand the ramifications of automatic enrollment and the potential for increased errors, and are willing to actively monitor the automatic features within their plans. Auto features can have a positive effect on retirement plans but it is important to explore both sides of the coin before deciding whether it is the best solution for your company’s plan. Are you ready to administer and monitor this provision? Do you have clean data and the systems in place to be perfect? Anything less than perfect could be costly for you.
About the Author(s)
Auto enrollment: Two sides to every coin
Auto enrollment for retirement plans helps employees start to save and also benefits plan sponsors by helping them address participation and testing challenges—but plan sponsors face steep penalties for any errors in the auto enrollment process.