Employers offsetting costs of automatic enrollment by reducing rate of required matching contributions

A recent study published by The Urban Institute indicates that employers that have adopted automatic enrollment features to their 401(k) plans have been reducing potential maximum match and or default match rates to offset the costs associated with increased plan participation.

By reducing matching contribution rates, employers can absorb the costs of automatic enrollment without cutting wages, reducing health benefits, eliminating matching contributions, or experiencing an increase in total plan costs. However, the lower match rates will not only reduce employer contributions, but may lead to lower employee contributions, resulting in retirement accounts that may be smaller than those of employees in plans that do not feature automatic enrollment.

Thus, while automatic enrollment has undeniably increased plan participation and enabled employers to increase contributions to highly compensated employees without violating the applicable nondiscrimination tests, it may result in reduced retirement savings by employees who have already enrolled in the plan or would have participated absent automatic enrollment.

Automatic enrollment safe harbor

Safe harbor rules implemented by the Pension Protection Act of 2006 allow employers that have not adopted automatic enrollment to avoid the applicable nondiscrimination tests by providing either: (1) a nonelective contribution of at least 3% of compensation for all eligible nonhighly compensated employees, or (2) a matching contribution of 100% of the first 3% of pay plus 50% of the next 2% of pay, for a maximum potential employer matching contribution of 4% of compensation.

Plans with automatic enrollment are further allowed to avoid the nondiscrimination tests altogether by maintaining a default contribution rate that is at least 3% of a participant’s pay in the first year of participation in the plan, increasing 1 percentage point annually after the first year, up to 6% of pay. The safe harbor requires employers to provide a matching contribution of 100% on the first 1% of pay, plus 50% of the next 5% of pay, for a maximum potential employer matching contribution of 3.5% of compensation. The lower matching rate under the safe harbor is designed to make automatic enrollment more attractive to employers.

Automatic enrollment generally restricted to new hires

Automatic enrollment has been warmly embraced by employers. The Plan Sponsor Council of America (PSCA) reported in 2012 that 46% of plans maintained an automatic enrollment feature in 2011 (compared to 24% in 2006). However, 82% of the plans surveyed by PSCA restricted automatic enrollment to new hires. This fact may reflect a desire by employers to minimize employer matching contributions and other plan costs.

Managing costs of automatic enrollment

Automatic enrollment increases employer costs by requiring employers to assume the added cost of: (1) funding the required matching contribution, and (2) maintaining and servicing a large number of small accounts. In managing the increased costs, employers have the option of: (1) reducing the matching contributions, (2) lowering compensation (other than retirement benefits) to keep total compensation at the same level as before the introduction of automatic enrollment; or (3) leaving the pension and other compensation arrangements unchanged, thereby increasing total compensation paid to employees.

In addition, or as an alternative to reduced match rates, employers may also establish a low default contribution rate. In fact, PSCA reported in 2012 that the most common default is 3% of pay. However, because automatically enrolled employees generally do not elect a contribution rate or asset allocation that differs from the company-specified default rate, automatic enrollment may actually result in lower plan contribution rates by participants who may have voluntarily saved at a higher rate, absent automatic enrollment.

Study reflects national data

The analysis by Barbara A. Butrica and Nadia S. Karamcheva reexamined prior studies of the means by which employers are managing the costs of automatic enrollment, using restricted microdata from the National Compensation Survey conducted by the U.S. Bureau of Labor Statistics (BLS). The data, which reflects the experience of single-employer defined contribution plans during the 2010-2011 period, illustrates not only the incidence of retirement benefits in plans, but provides information on employer costs. The data is significant in that it represents a broad, cross-section of employers throughout the country.

The study furnishes a thorough description of the practice of automatic enrollment programs throughout the country, breaking down the data by industry, region and employee demographics. Significantly, the study reports that plans with automatic enrollment have higher participation rates (77.1%) than plans without the feature (67.3%). However, the most compelling findings of the report are those highlighting the difference in matching rates between plans with automatic enrollment and those that do not include the feature.

Source: The Urban Institute Study, “Automatic Enrollment, Employee Compensation, and Retirement Security.”

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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