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What Is 401(k) Automatic Enrollment?

Donna Fuscaldo
Donna Fuscaldo
Senior Finance Writer
business.com Staff
Jan 19, 2022

Offering a 401(k) plan is doable, but getting employees to participate isn't always easy. An automatic enrollment feature can help.

In a tight labor market, small business owners have to pull out all the stops to recruit and retain talent. These days, even sign-on bonuses, generous salaries and the best employee benefits aren’t enough. Many small businesses are implementing 401(k) retirement plans, which have become almost an expectation for job seekers in a competitive post-pandemic labor market. 

But offering 401(k) plans and having employees adopt them are entirely different. While 60% of workers had access to an employer-provided retirement savings plan as of March 2020, only 43% participated in it, according to the Bureau of Labor Statistics

“The problem we found looking at the data is that the lower quartile of wage earners are the ones using it the least,” Daniel Beck, CEO and co-founder of 401GO, told business.com. “Services-based industries and very labor-intensive industries are quite hesitant, even though those are the ones that need the most help. The biggest issue with lower-wage earners not using the company 401(k) is it’s too dang complex.” 

The good news is there are ways to increase participation in 401(k) plans, including 401(k) automatic enrollment. Here’s a look at automatic enrollment, its benefits and drawbacks, and other ways to boost 401(k) participation. 

Did you know?Did you know? While 77% of people in management professions participate in a company-sponsored retirement plan, only 31% of service industry employees participate, according to the Bureau of Labor Statistics.

What is 401(k) automatic enrollment?

In a 401(k) automatic enrollment program, the business automatically deducts money from wages and deposits the money directly into the company-sponsored retirement savings plan. 

The employee can opt out or choose to contribute more if they wish. 

Did you know?Did you know? Any retirement plan that allows for elective salary deferrals can offer an automatic-contribution feature, including SIMPLE IRA plans.

How does automatic enrollment work?

There are three types of automatic enrollment that small business owners can offer.

  1. Basic automatic enrollment: Employees are automatically enrolled in the 401(k) plan unless they elect to opt out. The plan document lays out what percentage of wages will be automatically deducted. Employees can change the default percentage. 
  1. Eligible automatic contribution arrangement: The plan’s deferral percentage applies to all employees following the required notice. Some plans let employees withdraw automatic contributions within 90 days of the first contribution. 
  1. Qualified automatic contribution arrangement: The default deferral starts at 3% and gradually increases to 6%. The default percentage can’t be over 10% with this plan. 

Why do companies decide to offer automatic enrollment?

There are several reasons a small business owner will offer a 401(k) plan. Some want to access a tax-advantaged plan, while others use the 401(k) to recruit and retain talent. Many businesses offer a 401(k) plan because it’s the right thing to do. 

But sometimes businesses provide the plan and forget about it. They don’t encourage employees to sign up, which could put them at risk of failing the IRS Actual Deferral Percentage and Actual Contribution Percentage tests. 

Each year, plan sponsors are required to test their 401(k) plans to ensure the high earners in the company don’t make contributions disproportionately. If the company fails the test, it must correct the issue, including getting more rank-and-file employees to participate in the plan. 

This is where automatic enrollment comes in. With automatic enrollment, you ensure the plan is being used across the company, which means you’re less likely to fail the test. 

Automatic enrollment can also save a business money. “There is a tax incentive for organizations who choose to start a 401(k) plan that includes auto-enrollment provisions,” said Edward Gottfried, director of product for Betterment’s 401(k). “They may be eligible for an annual tax credit that offsets the cost of the plan.” 

Eligible businesses can claim a tax credit of as much as $5,000 for three years for the costs associated with offering a 401(k) plan and an additional $500 tax credit for adding an automatic enrollment on a new or existing plan. The credit is for the first three years the feature is offered.

Bottom LineBottom line: Automatic enrollment encourages employees to save for retirement, saves money for the business, and keeps the company in compliance with the IRS.

What are the drawbacks of 401(k) auto-enrollment?

While 401(k) auto-enrollment is designed to increase the amount of money workers save for retirement, there are some drawbacks to offering it. 

  • It disrupts the employees’ cash flow. Since the pandemic hit, 63% of Americans have been living paycheck to paycheck, research from Highland found. Auto-enrollment may make their situations worse, preventing them from saving for other goals or paying down debt. 
  • It could discourage higher savings rates. Employers also run the risk of implementing an auto-enrollment contribution rate lower than what workers would contribute on their own. While employees can raise the percentage, they tend to leave it at the default to make life easier. But if the percentage deduction is too high, employees may opt out of auto-enrollment altogether. 
  • It could have a reverse effect. Employees may contribute the default amount and think that’s enough. That will set them up for a major shortfall when they retire. 

TipTip: If you are looking for the best employee retirement plan options for your business, consider your company’s size, the variety of plan options, and the level of customer service you can expect from the company.

What are other ways to boost participation in your 401(k) plan?

For some small business owners, automatic enrollment doesn’t make sense. For these companies, there are other strategies to improve plan-participation rates. Here’s a look at some of the more effective ones. 

1. Speed up enrollment.

The easier it is for employees to enroll in the plan, the more likely they are to enroll. There are several apps, digital tools and in-person enrollment strategies small business owners can employ to speed up the process for employees. 

If employees have to sift through pages of paperwork and sign several documents to sign up for the plan, there’s a greater likelihood they won’t complete the process.

2. Give employees incentives. 

Incentivizing employees to enroll in the retirement plan can be an effective strategy. After all, the payoff for participating is years away, making it hard to convince employees to sign up. 

“If you give them a $50 Amazon card for the first time they set aside $25 a month, you create an immediate reward,” Beck said. 

3. Offer a healthy matching component. 

Free money can be motivating. Many companies will match a portion of employees’ contributions as an incentive. 

“A matching contribution is a great way to encourage employees, whether through a combination with auto-enrollment or independent,” Gottfried said. “It can really be a positive way to help reward them for sustained employment.”

Bottom LineBottom line: When you’re creating an employee benefits package, there are several effective ways to increase participation in your 401(k) plan. Make it easy to sign up, offer immediate incentives, and be generous with the matching component.

How can a PEO help you manage your 401(k) plans?

Some small business owners don’t want to manage their 401(k) plan in-house. That’s where a professional employer organization (PEO) comes in. PEOs provide a host of HR services, including benefits administration. 

A PEO operates under a co-employment model in which it legally takes on your employees. This gives the PEO a greater number of employees and thus more clout when obtaining competitive pricing on benefits, including 401(k) plans. When you use a PEO, you don’t have to worry about selecting and managing the 401(k) plan, and you’re apt to get a better deal than if you purchased it alone. 

The best PEO services offer customizable plans, competitive pricing and top-notch customer service. Below is a look at some of the more 401(k)-centric PEOs to consider.

Oasis

Oasis charges low plan administration fees and operates on a cloud-based platform that makes it easy for employees to sign up, track and otherwise engage in their plans. 

We like that Oasis keeps you in the loop with its monthly Sponsor Express email that updates you on the plan’s balance and performance. Read our comprehensive Oasis review for more information.

TriNet

TriNet stands out for its fee transparency – a feature not all PEOs share. Many times, fees are deducted from plan participants, which makes them hard to spot. TriNet lays out exactly how much it charges for managing the plan and what your employees will pay to invest. Read our in-depth review of TriNet for more information.

Rippling

Rippling makes it easy to track all your benefits under one dashboard. The company offers a robust suite of benefits, including 401(k) plans. What we really like about Rippling is its automatic enrollment feature. As soon as an employee onboards, Rippling invites them to enroll in the benefits.

Rippling also streamlines the enrollment process, enabling employees to review and select plans in minutes. Employers can track their progress in the Rippling dashboard. Read our comprehensive Rippling review for more information.

Help employees take advantage of your 401(k).

Offering employees tax-advantaged retirement savings vehicles is a must in today’s competitive labor market, but getting them to sign up is equally important. With 401(k) automatic enrollment, small business owners can ensure their staff takes advantage of this vital benefit. 

Image Credit:

Prostock-Studio / Getty Images

Donna Fuscaldo
Donna Fuscaldo
business.com Staff
Donna Fuscaldo is a senior finance writer at business.com and has more than two decades of experience writing about business borrowing, funding, and investing for publications including the Wall Street Journal, Dow Jones Newswires, Bankrate, Investopedia, Motley Fool, and Foxbusiness.com. Most recently she was a senior contributor at Forbes covering the intersection of money and technology before joining business.com. Donna has carved out a name for herself in the finance and small business markets, writing hundreds of business articles offering advice, insightful analysis, and groundbreaking coverage. Her areas of focus at business.com include business loans, accounting, and retirement benefits.