Find out whether an automatic enrollment 401(k) plan is right for you

By Max Berry


Saving for the future is every person's individual responsibility. But, as a small business owner, you have the power to provide your employees with some incentive. Instituting an automatic enrollment 401(k) plan may be as close as a you can come to guaranteeing that your employees will save. Automatic enrollment increases plan participation dramatically, but it also presents its own set of challenges for employee and employer alike. Read on to find out if automatic enrollment is right for your business.

The Case for Automatic Enrollment

The Pension Protection Act of 2006 requires employees to make a "negative election" or "opt out" of contributing to their employer's 401(k), otherwise payroll deferrals will be made automatically. The effects of the provision are clear: Given the choice to opt in or opt out of a retirement plan, a full third of workers opt out. Automatic enrollment plans cut that figure to less than ten percent.


Employers who stress the importance of saving, and make it easier for their employees to do so, will attract and retain workers who are more committed to the security of their futures and, naturally, their careers. Making enrollment automatic will also increase the number of lower-income workers who take part in the plan. This will help you pass the non-discrimination testing that comes along with many automatic enrollment plans. There are tax advantages as well. You may deduct your own contributions to your employees' funds and taxes on earnings are deferred until distribution.


Bear in mind that there is more than one type of automatic enrollment plan to choose from. The basic automatic enrollment plan, the eligible automatic enrollment plan, and the qualified automatic enrollment plan all vary slightly as to how funds are invested, how much, if at all, employers must contribute, and how accounts are vested. Ask your financial advisor for advice on which one is best for your business.


Going Automatic


If you are planning on instituting an automatic enrollment 401(k) for your business, consult with your bank, mutual fund, or insurance company first. Experts from your financial institution will help you develop a written summary of the plan's terms, set up a trust fund for assets, and create a recordkeeping system. If you already offer an elective 401(k), most of these things will already be in place. You will merely need to adapt the plan to encompass everyone and provide updated summaries of the plan's terms to your employees.


Set a regular percentage of employees' wages to be allocated to the 401(k), but make sure employees are aware that they may adjust how much they contribute. While automatic enrollment helps many employees-especially young ones who may have cause to worry about the future of social security-save for retirement, the median deferral rate for employers using the automatic enrollment system is only 3%, which may be below the rate many employees would choose on their own. Deferring a bit more of employees' salary-even 5% or 6%-could better prepare them for retirement.


You may also choose to contribute to employees' funds, either through matching contributions, a set percentage-of-compensation rate, or both. Under the basic and eligible contribution plans-though not qualified plans-employer contributions are optional. However, as a means of further encouraging participation, not to mention fostering goodwill with your employees, even a small employer contribution will go a long way.


Staying Within The Rules


Not long ago, fear of liability for losses on employees' investments discouraged some employers from instituting automatic enrollment plans. Recent changes in the law, however, relieve employers of that liability. When employees' contributions are used to make certain default investments-known formally as qualified default investment alternatives-that traditionally offer a high rate of return over the long term, the employer is not liable for any losses. Still, to avoid this concern altogether, and to promote a proactive attitude toward retirement saving, encourage your employees to research all the investments available through your plan and select those that most interest them.


And, perhaps most important of all, make sure everyone who is eligible for enrollment in your plan is, in fact, enrolled. According to the IRS, any employee age 21 or older who has worked at your company for 12 consecutive months, and has worked at least 1,000 hours over the course of those months, must be eligible to contribute to your firm's 401(k) plan. This includes employees who are not working for you full time. A thousand hours over twelve months breaks down to around 22 hours of work per week, which is why some employers hold their part-timers to 20 hours. IRS antidiscrimination rules also prevent retirement plans from favoring highly compensated employees over those who don't make as much. Setting up a "safe harbor" plan, where you make a 3%-of-income non-elective annual contribution to each employee's 401(k), will keep you well within the parameters of these antidiscrimination rules. For more information on 401(k) programs, visit or

Similar Content