The Curious Result of 401(k) Automatic Enrollment

Automatic enrollment, a feature formerly known as “negative election” have been around for about dozen years, but actually codified in the law in 2006.

Under the law, companies are allowed to automatically enroll workers in their 401(k) plans and have them defer a portion of their salary if the workers affirmatively opt out of deferring. The measure was intended to encourage more people to save, but the reason why it was implemented in the first place was to artificially bump up the deferral rate for non-highly compensated employees to help with the deferral discrimination test. Since the law in 2006, allowed fiduciary liability protection for plan sponsors who use a qualified default investment alternative (QDIA) in a participant directed, ERISA §404(c) based retirement plan, I have strongly supported it because I believe that it can be used as a mechanism to recruit employees to defer in the plan and get them so involved that they may affirmatively defer on their own..

Regardless, a recent study that was done for the Wall Street Journal and it showed that 40% of participant automatically enrolled would have deferred more money if they could have voluntarily done it on their own. Surprised? Initially, I was too. Then again, nothing in the retirement plan industry surprises me anymore.

There are a number of reasons for it. First off, as the article states, many plans set the automatic rate at a low percentage, usually 3% because many employers believe that any higher rate will have people opt out. There are a couple of other reasons that the articles fails to state, one is that the fault lies with the plan participants and it’s more sexy in an article to blame employers than participants. The reason why a large fault of it belongs to participants is because plan participants are a very apathetic bunch. So it’s not surprising that participants are too lazy to affirmatively defer more when it’s easier to do nothing and defer at the default auto rate. These are the same group of folks who don’t change their beneficiary forms when they should or never adjust their portfolio allocation or leave money with multiple former employers’ 401(k) plans.

Part of it rests with the employer and how they handle the automatic enrollment feature. Plan sponsors do a very poor job of handling the communications and notices from the third party administration (TPA) firm and the financial advisor. The fact that people can affirmatively defer more money is never highlighted because plan sponsors don’t know how to handle the process or they really don’t want it to be widely acknowledged that plan participants can opt out at all (either to defer more or defer nothing). They see automatic enrollment as that gimmick to artificially boost the discrimination results and want people automatically enrolled.

While automatic enrollment is a great gimmick to boost the savings for non-highly compensated employee, I think it should be seen more as a tool to combat the retirement crisis inn this country where pension benefits have been curtailed and Social Security is starting to resemble a ponzi scheme. If used properly and marketed with the help of a good financial advisor who knows how to captivate the attention of plan participants, automatic enrollment can be used as a tool to engage participants and get them involved on a voluntary basis. If plan sponsors are interested in truly having their employees save, they would increase the 3% rate either through auto escalation (like 1% a year) or at a higher amount like 6%.

Plan participants are an apathetic bunch, so it’s no surprise that automatically enrolling them would have the effect of lowering what people would save if they affirmatively elected to defer in a non-automatic enrollment plan.