One of the biggest challenges a plan sponsor can experience with their retirement plan is getting the employees to realize the true value of the benefit and having them actually take the step to enroll in the 401(k).
If you have a materialistic/paternalistic approach toward your employees, you may want the staff to save for their retirement years more than they do. If you have ever experienced this, you should know more about the options of Auto-Enrollment and Auto-Escalation.
I've been designing retirement plans with plan sponsors for about 15 years now. Throughout that time, I can't tell you how many sponsors have put in hours upon hours of work building the perfect retirement plan for their employees only to find out that the staff doesn't truly appreciate the benefit. I've also spoken with thousands of participants throughout the years who have said, "Man, I wish I had started this years ago!". If the employer wants the staff to enroll in the 401(k) and some of the employees should be saving more for retirement earlier, how can we help as an employer?
We all know that we should be saving throughout our working years in order to have an income to draw on in our golden years. The questions then become “When should I start saving?” and “How much should I save?”. The main problem is that most employees who do not participate in a 401(k) plan are under the impression that they cannot afford it. However, many of these employees have the discretionary income to save but they prefer to allocate this money toward other expenses (i.e., clothing, dinners out, dream vacations, etc.). So is this a situation where we can lead the horse to water but we can't make it drink? We actually have a couple of tools to encourage our employees to participate in the plan.
For years, the standard retirement program was designed as an opt-in plan. This means that the 401(k)’s default setting was that an employee would not be a participant until they took action and actually enrolled into the program. The trend over the past several years has shifted from an opt-in culture to more of an opt-out culture. The Auto-Enroll feature within a 401(k) gives the sponsor the power to design the plan in a way that all eligible employees will be enrolled into the retirement program unless the employee tells us otherwise. Under this arrangement, the plan sponsor says that all eligible employees will be enrolled into the 401(k) at a stated rate (2% of pay, 5% of pay, 7% of pay, etc.) when they become eligible for the plan. Now, some of my sponsors are initially tentative with this feature as they are concerned that they are adjusting their employee’s paycheck. If you have similar concerns, you should know that the employee has the ability to opt-out of the 401(k) any time before their eligibility date or after. So why would we do this? There are two primary reasons sponsors decide to implement the Auto-Enrolment feature: to help their compliance testing results and to look out for the financial well-being of their employees. Let's review these in more detail.
If you read my earlier entries on compliance testing, you'll know that many employers who sponsor a Traditional 401(k) Plan can experience issues passing their annual compliance testing. If you are one of these sponsors or you are considering implementing a Traditional 401(k) for the first time, the Auto-Enrollment feature could be a good fit for you. Since the greatest hurdle in passing compliance testing is getting your Non-Highly Compensated Employees and Non-Key Employees to participate in the plan, Auto-Enrollment could help your compliance results. The power of this feature is that people will often proceed with the default option and enroll in the plan because they would have to take action and opt-out of the very program that many Americans use to fund their retirement. Therefore, if the company culture states that employees are to be enrolled upon their eligibility date (opt-out plan), this inertia may make it more likely for the employee to participate than if they had to physically fill out the forms or setup their accounts online (opt-in plan).
If you genuinely have a materialistic/paternalistic dynamic with your employees, you may feel that setting up a retirement account is in the staff’s best interest in spite of what they believe (which could be one of the primary definitions of being a parent). Had you been a parent of one of your favorite employees, you might have told her that she must start saving 10% of her pay for retirement when she initially entered the workforce. As a parent, you might say that saving her money and investing is more important than the next happy hour, the shiniest new toy, or whatever other expenses you deem frivolous. You might also have the perspective that your child has yet to learn and that a dollar saved today can grow to many dollars down the road. You might even go so far as to ask them for a copy of their pay statement to verify that the 401(k) account was being funded. Although we cannot do this as employers, we can encourage them to participate by setting up the Auto-Enrollment feature.
Should you believe that the Auto-Enrollment feature is the right fit for your group of employees, we can take this a step further and implement the Auto-Escalation feature. This options says that the plan sponsor has the ability to increase the employees’ contribution amounts by a set percentage each year. Well, why would we do this? I can't tell you how many times a participant has told me “Yeah, I'm on top of my retirement savings. I put like 5% of my pay into the plan." That may have been a good step when the participant was in their 20s but we generally recommend that a participant should contribute approximately 15% of their total annual compensation to the retirement plan. Likewise, through the course of one's career, many employees earn greater compensation later in life than when they first entered the workforce. If this is the case, we should have the ability to defer more into the 401(k) plan as we continue through our careers.
If you are having challenges getting your employees to participate in the retirement benefit, I highly suggest you consider these automatic features for your plan. Join us next week when we discuss the Attribution Rule and why some business owners have issues passing compliance testing…