In-Depth: Rethinking Auto Enrollment

April 4, 2002 ( - McDonald's Corporation's recent decision to discontinue its automatic enrollment program raised a few eyebrows. After all, the famed franchise was the first to roll out the program.

But McDonald’s has a point, defined contribution experts say. They say auto enrollment as it is currently implemented in many companies, simply increases participation rates but does not push employees to save responsibly for retirement.

Indeed, a spokesperson for McDonald’s told the Wall Street Journal that since ending the program, the company has noticed an increase in the amount employees are contributing to their 401(k) plans. This included a slight boost in the company match for worker contributions and more flexibility to diversify plan assets.

Marginal Participators

“McDonald’s claim that once it ended the program they saw an increase in the average amount of participant contributions makes sense because the marginal participators in its plan were eliminated,” said Andrew Metrick, a finance professor at the University of Pennsylvania at Wharton.

“With automatic enrollment it’s possible to have a 96% participation rate but only a 54% active participation rate. Once the marginal plans are eliminated the rate of participation goes up and diversification changes because the participants left are those that probably already actively manage their accounts.”


Still, many companies started their automatic enrollment programs for reasons that still apply. They became interested in offering it because of their constant failure to pass the non-discrimination rules the Internal Revenue Service applies to pension plan provisions.

As a result of their failure, many companies had to either make 401(k) contribution refunds to highly compensated employees or retroactive company contributions on behalf of employees who were not highly compensated to come into compliance.

Additionally, many companies tried to reduce the possibility of non-discrimination testing problems by limiting the contributions that highly compensated employees could make.

They hoped that through automatic enrollment they could foster higher participation rates among their non-highly compensated workforce and end their worries over non-discrimination testing.


Viewed from this perspective, automatic enrollment works. A 2001 Vanguard study found that automatic enrollment does help increase participation rates. The firm noticed that for plans that automatically enrolled newly eligible employees, participation rates rose from 75% to 84%.

A few plans that enrolled all eligible employees saw their participation rates soar from 73% to 90%. Studies by Harvard University, Wharton and the University of Chicago confirmed these findings.

So, it came as no surprise that more sponsors signed on. A 2001 Hewitt Associates survey found that 14% of companies utilized automatic enrollment, up from 7% in 1999.


The initial euphoria masked the downsides. Participants were still not saving enough and often tended to become passive with regard to their 401(k) investments.

“Even though you may increase the number of people participating, you don’t necessarily increase the amount of money they save,” said Robin Credico, a senior defined contribution consultant at Watson Wyatt. “Many employers decide to elect low deferral rates in conservative investments. If a participant is enrolled this way they are less likely to change the amount they save and their investments line up.”

According to the Profit Sharing Council of America’s 2001 survey on automatic enrollment, the average deferral rate for automatic enrollment plans is 5.6%. However, 60% of the companies surveyed offered a 3% deferral. At the same time, the survey reported that 45.8% of plans offered a stable value fund as its default investment choice with money market and balanced stock/bond funds coming in second at 20.8%.

Amy Reynolds, a principal at William M. Mercer Consulting Inc., said some participants could be confused and perceive that their employers are endorsing the plan’s default.

“This could be why we’ve seen large numbers of participants at plans utilizing auto enrollment who contribute at the lower deferral rate,” said Reynolds. “But, we also figure that there is a tremendous inertia to move away from the default.”

Reynolds continued that employers have to be clear of their objectives before rolling out automatic enrollment because it does not solve participation problems immediately.

Moving Ahead

“Plan sponsors should know that their job is not done by virtue of putting automatic enrollment in place,” she said. “If a sponsor’s objective is to get more bodies into the plan, it will do that. But, if a sponsor’s objective is to get a higher deferral rate and investment diversification, participants will need to be educated on how much they should be contributing and at what percentage and also in what investments they should allocate their assets.”

David Wray, president of the Profit Sharing Council Of America (PSCA) has said that some employers have found that automatic enrollment programs lead to numerous small accounts that are expensive to maintain and has prompted some of them to abandon automatic enrollment. 

Wharton’s Metrick agreed but said that the cost of maintaining small plans is not the issue and does not lessen automatic enrollment’s viability to 401(k) plans.

“The first generation of auto enrollment programs led to small accounts and the wrong kinds of participation levels and thus the wrong kinds of investment patterns,” said Metrick. “What needs to be done is that, instead of defaulting people into these super safe investments and a 2% deferral rate, employers get people to save differently by allowing them to change their deferral rates over time or by defaulting people into more reasonable investments,” he said.

There is some encouraging news. Vanguard’s survey found that a number of plans moved away from the typical 3% deferral rate. Twenty-five percent of the companies it surveyed chose a default savings rate of 4%.

Wyatt’s Credico said that some companies are beginning to look into what is known as the Smart401k plan. Like auto enrollment, the program would automatically enroll eligible participants into the company’s 401(k) plan. However, every time an employee receives a pay increase, his or her deferral rate would go up.