When automatic enrollment doesn’t make sense for 401(k) plans

Automatic enrollment has exploded in popularity over the past decade, and is widely seen as a best practice in 401(k) plans to boost participation and employee savings.

Adoption by 401(k) plan sponsors has more than doubled since 2006, when the Pension Protection Act codified certain incentives for having automatic enrollment. Roughly 58% of plans now use it, with adoption being greater among larger plans, according to the Plan Sponsor Council of America.

However, there are some situations in which the plan-design feature doesn’t make sense.

“Auto-enrollment is a great thing, but it has its drawbacks,” Barbara Delaney, principal at StoneStreet Advisor Group, said.

DEMOGRAPHICS

Industry and employee demographics play a large role.

Implementing auto-enrollment at companies with a high degree of employee turnover and relatively low wages — the retail and hospitality industries, for example — can create several small accounts that contribute to administrative headaches and may increase plan fees, advisers said.

Record keepers typically price based on the average account balance of participants — the lower the average balance, the higher the cost.

Plan sponsors have a few mechanisms to eliminate these small balances. They can cash out balances of a former employee with less than $1,000 and mail a check to the participant; or, for balances of $1,000-$5,000, they can roll participant money out of the plan into an individual retirement account.

But these processes don’t always go smoothly. An employer needs to ensure checks are properly delivered in order to kick out participants, but checks sometimes bounce back if the employer doesn’t have the correct mailing address on file, for example, said Aaron Pottichen, retirement services practice leader at CLS Partners.

“The administrative burden may be more than the benefit of getting people to save. It’s unfortunate, but it’s a reality we have to deal with,” Mr. Pottichen said.

Plus, some plan sponsors are opposed to the idea of cashing out participants, Ms. Delaney said.

Plan design may be able to overcome these burdens to a certain extent. For example, if most turnover occurs within 90 days of hire, auto-enrollment can kick in after 90 days, Susan Shoemaker, partner at Plante Moran Financial Advisors, said.

OPERATIONAL FAILURES

Employers likely to not pay close attention to the processes and procedures associated with auto-enrollment are poor candidates for the feature, because administrative failures can be costly, advisers said.

“Having auto-enrollment with people who can’t do it properly is a big risk,” Mr. Pottichen said.

One of Mr. Pottichen’s clients is currently being audited by the Department of Labor for failing to make employer contributions to automatically enrolled employees. The company not only must provide the missed contributions for 2014-15, but also any missed earnings on those contributions and potentially amend their Form 5500 document.

“Some people don’t have the proper training/support to administer it properly,” Mr. Pottichen said.

COMMUNICATION

Using auto-enrollment among small organizations — roughly 100 employees or less — with a centrally located staff (rather than, say, 30 different offices) could actually have a negative impact on savings, Ms. Shoemaker said.

It’s much easier to communicate with employees via group and one-on-one meetings to educate them about the benefits of saving in a retirement plan at these sorts of organizations; these employees tend to save a greater share of their income than if they’re automatically enrolled, she said.

The average deferral rate for organizations with between 50 and 199 participants and using automatic enrollment is less than those companies that don’t use automatic enrollment — 5.2% versus 7.7%, respectively, according to the PSCA.

Similarly, companies whose employee communication is lacking are likely poor candidates for auto-enrollment.

“Auto-enrollment works best when you have a robust educational component as well, because people need to know they’re being auto-enrolled” and the window for opting out of the plan is limited, Anthony Domino, Jr., managing principal at Associated Benefit Consultants, said.

COMPANY PHILOSOPHY

Some employers are opposed to implementing auto-enrollment due to the philosophy of their employees, advisers said.

“At some organizations, the culture is already skeptical of management and they look at it as negative,” Ms. Shoemaker said.

Sometimes, though, employers have a misguided perception of employee sentiment. Ms. Shoemaker relays auto-enrollment success stories of similar clients, and even puts a hesitant client in touch with others who’ve achieved success in order to combat reluctance.