Should Your Plan “Go Extreme”?

Participants value “extreme” 401(k) plans, according to another survey, this one undertaken by American Century Investments.  What is an extreme plan and how does it benefit plan participants and sponsors?  And is an extreme plan one that employers can easily adopt?

Going extreme involves embedding a suite of features in a plan’s design and policies to automatically enroll participants, increase their retirement savings and help them invest properly.  Doing so sets participants on the road toward a secure retirement, and employers offer an appreciated benefit at little cost to their organization.

“Extreme” features include:

1. Auto Enrollment with at least a 6 Percent Deferral Rate – Participants are automatically enrolled when they first become eligible and again annually if they reduce their deferral or opt out.

70 percent of those participants responding to the American Century survey favored being automatically enrolled at a 6 percent deferral rate.  Auto enrollment makes participation easy for employees, and it counters the natural inertia that causes some never to save for retirement.

With auto enrollment, participants must be notified before they are enrolled and given a chance to change their deferral (up or down, including to a zero deferral).   Employers also may include in their plan’s design the ability to reset participants at the initial deferral rate at the beginning of each plan year for participants who had previously reduced their contribution or opted out.

Higher deferral rates were acceptable to participants responding to the American Century survey.  Many auto deferral rates are 3 percent, but this amount is considered inadequate to build meaningful retirement assets.  A recommended initial default is 6 percent.  Other research has shown no significant difference in opt out rates for a 6 percent versus a 3 percent default, regardless of the employer’s contribution.  

2. Auto Escalation – Participants who remain at the auto enrollment rate are automatically escalated at the beginning of the next plan year after their first full year of participation.

Two-thirds of American Century respondents favor this option, which can occur incrementally to a deferral rate of as much as 15 percent.  Again, participants must be notified and may reduce deferral rates or opt out.

Some sponsors balk at using auto features, expressing concern that they are “telling” employees how they should manage their finances.  As American Century – and other research – indicates, employees appreciate auto features that help them start saving and defer adequately.  Gone for many are the pension plans that tied benefit amounts to a portion of salary.  Most participants don’t know what constitutes adequate savings. Employers provide a valuable benefit when they help employees enroll and escalate to savings levels shown to provide meaningful retirement income.

3. Re-Enrollment – This “extreme” 401(k) plan feature aims to help ensure participants are “properly” invested.  As all participants are re-enrolled, they are provided education on the plan’s investment options and defaulted into the plan’s Qualified Default Investment Alternative (QDIA) if they make no investment decision. 

Sponsors cannot be held liable for the investment defaults as they re-enroll participants when they do so under ERISA 404(c)5.  This section of ERISA allows the use of the QDIA.  Target date funds and more strategic managed accounts may serve as qualified defaults.  Participants may be moved into such alternatives based on some criteria, such as age.  Before the default occurs, participants must receive notice that they will be re-enrolled and placed into the QDIA unless they make an alternate selection.

In addition to explaining plan investment alternatives, re-enrollment education should include presentations that encourage retirement savings.  There should also be an opportunity for participants to consult with the plan’s investment advisor.

While plan documents create the opportunity for re-enrollment, sponsors will want to include in their Investment Policy Statement the criteria used in selecting the target date fund series or the managed accounts that become the qualified defaults, as well as the criteria used to determine into which funds participants will be defaulted.

The American Century survey found that employers who adopt “extreme” 401(k) plans generally enjoy higher ratings from employees.  Sponsors should consult with their advisors and Third Party Administrators to adopt the plan features that permit automatic enrollment and deferral, automatic escalation, and re-enrollment.  Plan advisors can assist with investment selection and default documentation in Investment Policy Statements, as well as re-enrollment education and guidance to participants.  An additional benefit to employers is the tax incentives available to them under the recently-passed SECURE Act should they first adopt automatic enrollment after January 1, 2020.

 This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans.  Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.