Jump Start Your 401 (k) Plan with Auto Enrollment
By Randall W. Cook
SAALFELD GRIGGS PC
Although 401(k) plans serve as hugely popular savings vehicles for millions of Americans each year, studies show that less than half of all eligible employees across the nation actually participate in their employer-sponsored 401(k) plan. In the age 18 to 25 demographic, the statistics are even more dismal, with less than 18% of otherwise eligible employees signing up for their employer’s 401(k) plan. The reasons given by this age group for non-participation are varied, but most revolve around either their disposable income (i.e., “I just can’t afford it”) or their apathy (i.e., “I just don’t care”).
Poor participation in a 401(k) plan not only hurts the young employee who is failing to save for retirement at exactly the time he or she should be saving, but also the owners and other “highly compensated employees” (“HCEs”) who are trying to participate in the plan for themselves. This is because most 401(k) plans (other than “safe harbor” 401(k) plans) condition the amount that an owner or other HCE can defer into the plan on the average deferrals of the non-highly compensated employees (“NHCEs”). This is known as the “average deferral percentage test” (“ADP test”), which basically says that if the NHCEs don’t contribute, then the owners and other HCEs can’t contribute.
For many years, employers with poor participation rates in their 401(k) plans have toyed with the idea of automatically enrolling eligible participants in the plan. Auto enrollment 401(k) plans (also sometimes known as “negative election” plans), provide that, once an employee meets the eligibility requirements of the plan, the employer will automatically begin withholding deferrals at a pre-determined rate, and will contribute those deferrals to the 401(k) plan. Although auto enrollment plans always give the employee the option of affirmatively electing not to have wages withheld for 401(k) purposes (i.e., the “negative election”), the default in such plans is that, unless the employer receives a written election to the contrary, the employee is automatically enrolled in the plan.
Historically, the greatest barrier to adopting an auto enrollment 401(k) plan has been state wage and hour laws. In some states, like Oregon, auto enrollment plans would appear to be in direct contravention of state statutes, such as Oregon Revised Statutes 652.610, which generally provides that an employer can only withhold from an employee’s wages amounts that the employee has authorized in writing to be withheld. Of course, with an auto enrollment 401(k) plan, there is no authorization in writing.
Under the recently-enacted Pension Protection Act of 2006 (“PPA ’06”), effective August 2006, the concern over state wage and hour laws has been eliminated. PPA ‘06 specifically provides that auto enrollment 401(k) plans are now legal, and that any state wage or hour law to the contrary is pre-empted by federal law. However, in order to qualify as a PPA ’06 “eligible” auto enrollment 401(k) plan, the plan must meet certain requirements. Among those requirements are: (a) that the plan apply a uniform deferral percentage among all otherwise eligible participants who do not complete their deferral forms; (b) that the employee be given the right to cancel the deferral and obtain a refund of the deferred wages if requested within 90 days of the date that deferrals began; and (c) that the employer give the participant an annual notice which reminds the participant that deferrals are being deducted from his or her wages, and that he or she has the right to cancel those deferrals.
So, how effective will auto enrollment plans be in increasing participation? Apparently, they will be very effective. In states where auto enrollment is already being used (i.e., in states where auto enrollment does not contravene the state’s wage and hour laws), studies show that of all participants who are automatically enrolled in their company’s 401(k) plan, approximately 85% remain in the plan, despite the fact that they are given the option to elect out. In such plans, failed ADP tests are virtually non-existent, and younger participants, who perceive that they cannot afford to save for retirement, learn otherwise. If you are interested in learning more about auto enrollment 401(k) plans, please contact our Employee Benefits Group.