Automatically enrolling
employees into a 401(k) plan is not right for every
employer, but creative implementation strategies can
overcome many of its drawbacks
The reasons for not embracing automatic
enrollment—withholding money from employee pay and
investing it in a retirement savings plan without first
obtaining a signed enrollment form—are readily cited.
Employees could subsequently, and with perfect 20/20
hindsight, conclude their plans were not performing
well—and sue for damages. Costs could go up, both in the
form of additional employer contributions and more account
maintenance fees. There are potential legal ramifications
(see "The Legal Issues," page 40). Finally, it
smacks of Big Brother. As one plan sponsor responded to a
recent PLANSPONSOR NewsDash survey, "Who are we to be
telling our employees how to spend their pay?"
Not surprisingly, many employers shun automatic
enrollment despite its endorsement by the Department of
Labor, the Internal Revenue Service, and many plan
providers. In our
2005 Defined
Contribution Survey
(PLANSPONSOR, November 2005), only about 14% of
responding employers said they have embraced it, though the
trend was more pronounced among larger employers.
Yet, Unicoi County Memorial Hospital in Erwin,
Tennessee, needed only one reason to add an automatic
enrollment feature to its retirement savings plans
beginning this April: It thought it would be good for its
employees. "We only have about 43% of our employees
participating in our plans," says Toni Buchanan, chief
financial officer of the 48-bed hospital. "Our investment
committee decided that, in the best interests of our
employees, any new hires would be enrolled automatically to
get them involved in the retirement process." The idea that
the hospital is somehow usurping employees' discretion
over their pay does not fly with Buchanan. "I don't
look at it as telling people what to do with their money,"
she says. "I think we're trying to look out for them."
Buchanan says the new feature applies to both the 403(b)
plan the hospital operates for its own employees and the
401(k) plan it operates for a hospital-owned physicians
office. Together, the two operations employ about 260
people and have about $3.5 million in retirement plan
assets. The hospital is setting the deferral rate for its
automatically enrolled participants at 3% of their salary,
and kicking in 4% on its own.
Like Unicoi County Memorial, Morrison Textile Machinery
Co. in Fort Lawn, South Carolina, had employee interests in
mind when it introduced automatic enrollment to its 401(k)
plan in January, says Lindell Robinson, chief financial
officer. The owners of the privately held 120-employee
enterprise had several objectives, Robinson says. "However,
the primary reason was to benefit the employees. This is
the retirement option we offer, and we feel an obligation,
as people work through their careers here and ultimately
retire from here, to be sure they have something they can
rely on." Retirement plan providers say this paternalistic
view is common among employers now embracing automatic
enrollment, a plan feature that started to take root in the
late 1980s but only began gaining broad appeal in the past
several years, largely due to a series of government
endorsements. The Internal Revenue Service issued a revenue
ruling in 1998 that explicitly allowed automatic enrollment
for new hires, then followed up with another ruling in 2000
that expanded that blessing to other defined contribution
plans, including 403(b) and 457 plans, and to current as
well as new employees. That same year, then-Secretary of
Labor Alexis Herman and then-Treasury Secretary Lawrence
Summers issued a joint statement encouraging employers to
embrace automatic enrollment. "With a lot of the early
adopters, it was more to deal with discrimination-testing
issues," says Cynthia Hayes, head of employer plans for
Merrill Lynch & Co.'s Retirement Group business. "Over
the last 12 months, it's become more of a paternalistic
issue for many plan sponsors; they believe it's the right
thing to do for their employees."
Jeff Crenshaw, a principal with CapTrust Financial
Advisors in Charlotte, North Carolina, says he encourages
all of his plan sponsor clients to embrace automatic
enrollment. He estimates 80% have done so or are in the
process. "I haven't had any say no," he reports. "I have
had them say 'Give us more time.'" The biggest concerns
among those who are being cautious, he says, revolve around
the appropriateness of taking money out of an employee's
paycheck without her consent and deciding how to invest it
on her behalf. Numerous surveys—including several by the
Profit-Sharing/401(k) Council of America and Hewitt
Associates' "2005 Trends and Experiences in 401(k)
Plans"—show that more than half of employers who implement
automatic enrollment still default contributions into a
stable value or money market fund, with the remainder
typically choosing balanced stock and bond funds.
Clare Bergquist, director of service strategies for plan
provider Charles Schwab & Co., says that, historically,
employers have favored "safe" stable value and money market
options on the theory that participants who do not lose any
principal will be less likely to sue them. Early proponents
of that approach also operated under an assumption that the
investment was a starting point for newly minted
participants who would soon become engaged with the
retirement accounts that had been established on their
behalf. Subsequent research has indicated that participants
who are automatically enrolled are no more inclined to
rebalance those portfolios than those who take the time to
fill out the form. Nor do many ever bother to increase
their contributions beyond the default rate established by
their employer, many of whom set the rate at 3% of salary—a
figure that became popular after the IRS used it as an
example in its 1998 revenue ruling.
For plan sponsors, then, the issue becomes not how
should the deferral be invested for the long term, but how
should it be invested prudently for the duration of the
account? In that context, investment professionals
generally argue that "safe" investments such as stable
value and money market funds, when they are the only asset
in a portfolio, do investors a disservice by robbing them
of the growth opportunities afforded by a more diversified
portfolio that includes stocks. Oregon Steel Mills, Inc.,
ofPortland, Oregon, a Schwab client, defaults automatically
enrolled participants in its 401(k) plans into target-date
lifecycle funds - specifically one of four of
Schwab's Managed
Retirement Trust Funds
. "I think they're better from a participant standpoint,"
says John Worcester, the company's manager of compensation
and benefits, "because of the way they're professionally
managed and have assets allocated in an intelligent way."
Oregon Steel operates two 401(k) plans: one for union and
one for non-union employees. Together, they have about
1,400 -active participants and $73 million in assets.
Some employers also push the automatic enrollment
envelope by selecting initial deferral rates that exceed
the 3% of -salary still favored by most plan sponsors, even
though the IRS issued a general information letter in 2004
clarifying that the default deferral rate can be any amount
permissible by plan design within Internal Revenue Code
limits. Morrison Textile Machinery, a CapTrust client, sets
the deferral rate for its automatically enrolled plan
participants at 6% of salary so they get full advantage of
the company's matching contribution of 50% on the first 6%
of salary. Oregon Steel defers 4% of salary for
automatically enrolled non-union employees, which the
company matches dollar for dollar. Its union employees
enrolled automatically get a 2% deferral rate and 1%
company match, but also benefit from what Worcester calls a
"generous" defined benefit plan.
Supporters of automatic enrollment say there are
creative ways to get around many of the concerns that
sponsors cite when rejecting the concept. Those concerned
about taking the participation decision out of employees'
hands, for example, can beef up their communications effort
to make sure employees know about the automatic enrollment
feature and the benefits of plan participation, as well as
their right to opt out. Sponsors also can delay the timing
of the actual enrollment process so that employees have
ample opportunity to take action. At Morrison Textile
Machinery, for example, new employees are told about
automatic enrollment when hired, but are not actually
enrolled until six months later. At Unicoi County Memorial
Hospital, the waiting period is 90 days. Hayes says one
large retailer using automatic enrollment waits two years
before defaulting workers into its plan, partly to avoid
the problem of being left with thousands of small account
balances to maintain. Turnover is high among retail
workers, particularly during the first two years of
employment. Hayes also notes that, if the cost of the
employer match is a concern, plan sponsors can delay
implementation of those contributions.
More broadly, Hayes argues that automatic enrollment
plans should be complemented by features that automatically
and periodically increase participants' deferral rates and
either provide advice or automatic investment selection.
While automatic enrollment may not be right for every
401(k) plan (see "Is Auto-Enrollment Right for You?"
above), innovative plan design can mitigate many of the
challenges. There is no question that it can boost
participation rates, improving the retirement outlook for
employees who otherwise might not accumulate any nest egg
at all. At Oregon Steel, for example, automatic enrollment
has pushed participation in its union plan to about 60% of
eligible employees from 47%, and in its non-union plan to
about 82% from 50%. The broader question plan sponsors must
ask themselves is whether automatic enrollment alone is
enough to ensure a successful 401(k) plan. It is not.
top