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The Merits and Hazards of 401(k)
Auto Enrollment
www.hrp.net
Most employers now automatically enroll employees
in their 401(k) plan, and many of them also
automatically ra...
The Price of Recordkeeping Snafus
The IRS comes down hard on employers who neglect to begin processing
employee deferrals ...
www.hrp.net
Any time you've missed at least three months' worth of deferrals and
matches, to compensate for the error you ...
Auto-Escalation Malfunction
In a perhaps more likely scenario, suppose your plan features a 1 percent
annual auto-escalato...
Additional Considerations
Even with no snafus of the types noted above, there's more to consider. For
example, some record...
www.hrp.net
Also, employees who leave the company relatively soon after joining -- often
the kind of employee who does not...
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The Merits and Hazards of 401(k) Auto Enrollment

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Most employers now automatically enroll employees in their 401(k) plan, and many of them also automatically ratchet up employees' deferral rates, according to a recent survey. While the practice over the years has contributed to greater employee participation in these retirement plans, there are some possible drawbacks to the strategy, as well as penalties for any inadvertent failures to credit employees' accounts properly.

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The Merits and Hazards of 401(k) Auto Enrollment

  1. 1. Toll Free: 877.880.4477 Phone: 281.880.6525 www.hrp.net The Merits and Hazards of 401(k) Auto Enrollment
  2. 2. www.hrp.net Most employers now automatically enroll employees in their 401(k) plan, and many of them also automatically ratchet up employees' deferral rates, according to a recent survey. While the practice over the years has contributed to greater employee participation in these retirement plans, there are some possible drawbacks to the strategy, as well as penalties for any inadvertent failures to credit employees' accounts properly. Here's a closer look. » First, the numbers. The survey* by World at Work showed 56 percent of employers have an auto-enrollment feature. More than half of those who auto-enroll also employ an auto-escalation feature, generally within the 1 to 2 percent range. Employers who combine those features -- auto-enroll and auto-escalation -- tend to be a bit more conservative when it comes to setting the initial default deferral rate. Most begin with a rate of 3 or 4 percent. Here are some of the downsides and risks to keep in mind.
  3. 3. The Price of Recordkeeping Snafus The IRS comes down hard on employers who neglect to begin processing employee deferrals and employer matching contributions on a timely basis. While this pertains to all 401(k) plans, with or without auto-enrollment and auto-escalation features, the probability of errors rises with the number of employees pushed into enrollment or changes in deferral amounts. www.hrp.net Suppose Judy, an employee with an $80,000 annual salary, joins your company on January 1, and is auto-enrolled into your plan with a 4 percent deferral amount. Assume further that your plan matches 100 percent of deferrals up to 6 percent. Here is a simple example developed by Kari Jakobe, a principal with the Milliman pension consulting firm, to illustrate the point: Unfortunately, there was a mix-up and no deferrals (and thus no matches) were parked in Judy's 401(k). Since she never actively took a step to enroll in the plan in the first place, Judy didn't notice a problem. The oversight wasn't noticed for a year. » »
  4. 4. www.hrp.net Any time you've missed at least three months' worth of deferrals and matches, to compensate for the error you are required to contribute: • 100 percent of the foregone match ($3,200 in this example), • 50 percent of the foregone deferral ($1,600), and • A "reasonable" investment return. In this example, an 8 percent annualized return would have resulted in an accumulation of $384. These figures add up to $5,184. Without the auto-enrollment feature, it is more likely there would have been no error, and you would not have to cough up that amount. Had everything gone according to plan, and assuming Judy decided she was content to be enrolled in the 401(k), you would have been out only $3,200, which is the amount of the matching contribution. Clearly, this is a costly mistake.
  5. 5. Auto-Escalation Malfunction In a perhaps more likely scenario, suppose your plan features a 1 percent annual auto-escalator on the deferral. Suppose further that Judy was auto- enrolled properly when hired, and didn't opt-out. But in the second year, Judy's annual salary remains at $80,000, and a glitch occurs: Judy's monthly deferral of $267 isn't bumped up by 1 percent ($67) as it should have been. That would mean she contributed $800 less than intended over the course of the year in salary deductions, and also missed out on another $800 in matching contributions, plus an assumed $96 in foregone earnings. If it took a year for the error to become apparent, the net effect would be that you would need to contribute $1,296 to Judy's account, based on covering half of the amount that would have been deferred, 100 percent of the match that didn't happen, and the $96 in earnings. Most recordkeeping systems do an excellent job, but ultimately depend upon input by humans at some point in the process, and people are not infallible. Besides the cost in dollars, you pay a price in credibility with employees. www.hrp.net
  6. 6. Additional Considerations Even with no snafus of the types noted above, there's more to consider. For example, some recordkeeping charges are flat, per-participant amounts. If you are effectively prodding employees into participation and those employees later opt out – leaving small 401(k) account balances – the effect may be to drive up recordkeeping costs for participants who truly want to be in the plan. www.hrp.net
  7. 7. www.hrp.net Also, employees who leave the company relatively soon after joining -- often the kind of employee who does not contribute aggressively to a 401(k) -- may leave you with small accounts to keep track of. If such employees leave and don't stay in touch, you'll face the burden of trying to track them down in order to distribute the proceeds of their account. These potential pitfalls are not necessarily a reason not to have auto- enrollment and auto-escalation features in your 401(k) plan. Rather, they are factors to weigh as you undergo your decision-making process, as well as your scrutiny of recordkeeping service providers.
  8. 8. 14550 Torrey Chase Blvd., Ste. 360 Houston, TX 77014 USA www.hrp.net E-mail : info@hrp.net Toll Free Phone Fax : : : 877.880.4477 281.880.6525 281.866.9426

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