Automatic enrollment is a practice aimed at getting employees to participate in a 401(k) plan by default. There are two theoretical benefits to auto enrollment: (1) more employees begin to accumulate retirement savings and (2) auto enrollment can improve nondiscrimination test results, which would enable highly compensated employees to defer more income into the 401(k) plan.
To date, auto enrollment has not met with great success. A recent study found that only 8% of employers are utilizing the approach. In actual practice, participation rates tend to steadily decline as participants seek to maximize their take-home pay. Other major hurdles to auto enrollment’s success have been state laws that appear to prohibit employers from withholding compensation from employees’ pay without written approval and a concern over how employers should invest auto enrollment contributions in the absence of clear instructions from participants.

But despite the relatively cool reception auto enrollment has received, Congress is considering new legislation that aims to make it more appealing to employers. In April, Representative Rahm Emanuel introduced a bill confirming certain state laws do not supersede automatic enrollment. The bill also proposes protecting employers from possible liability for investment losses in the automatically enrolled money. Later that month, Senator Jeff Bingaman introduced a similar bill that also incorporated a safe harbor automatic enrollment plan. Under this arrangement, employers who implement auto enrollment and provide a 3% non-elective contribution or a matching contribution of 50% of the first 7% of compensation (a 0.5% lower than the current requirement) to participants would be rewarded with a “free pass” on nondiscrimination tests.

Safe Harbor Plans: A Possible Alternative to Auto Enrollment

Employers who anticipated better nondiscrimination test results as an added benefit of auto enrollment are often disappointed. What auto enrollment tends to do is create a false improvement in nondiscrimination test results during the first year of introduction. As participants discontinue their auto enrollment deferrals, test results deteriorate.
If employers want to permit highly compensated employees to defer up to the annual limit, they may want to consider a safe harbor plan design. Although the safe harbor feature requires an employer contribution of either 3% or a matching contribution of 100% of the first 3% of compensation, plus 50% of the next 2%, the reward is the free pass noted above on the deferral test. As a result, highly compensated employees would be able to defer up to the annual limit. This approach may be the solution to the failed ADP test problem that can’t be solved solely by auto enrollment.