Auto enrollment has quickly become a significant part of the 401(k) landscape. The use of this approach, previously known as negative enrollment, is now considered by many to be a best practice.
Where criticism of auto enrollment is expressed, it is typically focused on the investment solution that is tied at the hip to the auto-everything phenomena: target-date funds. The debate regarding target-date funds will continue with no end in sight—although the growth in assets in this category reflects the industry’s embrace of the concept.
What is not discussed as a weakness of the auto approach, but which might prove to be one of its worst attributes, is that most participants who are auto enrolled have no beneficiary designation, given that it is not possible to “auto elect” a beneficiary. Further, requiring a valid beneficiary election for each participant would short circuit the auto enrollment process. HR can’t begin deferrals automatically for an employee if that process requires pre-emptive action in the form of a beneficiary election. The recordkeeping community has settled on a fairly straight-forward solution: Don’t ask auto enrollees for a beneficiary designation at the time they are auto enrolled.
Second Wives vs. Children
A related issue: Participants may plan to leave their accounts to their children from an earlier marriage but fail to provide the necessary spousal waiver form, signed by their current spouse. Without a signed waiver, the spouse would inherit the account as directed by the Employee Retirement Income Security Act—even if the participant had designated the children as beneficiaries, or noted that intention in his or her will. (See "Family Feuds: The Battles Over Retirement Accounts," Wall Street Journal, September 2011.)
Follow-Up Isn't Working
Most plan sponsors using auto enrollment haven’t heard this part of the story. The biggest reason is the belief that the need to save outweighs the need for a beneficiary. Few would argue with the notion that we need to save more.
The most common way that a plan sponsor hears about the virtues of auto enrollment is from the financial firm performing recordkeeping and administrative services for the plan. Auto enrollment is cited by recordkeepers as a way to increase participation, increase savings rates (especially when combined with an annual auto-increase) and pass discrimination tests.
When it comes to the beneficiary designations, or lack thereof, the recordkeepers assure their plan sponsor clientele that they will follow up with reports identifying those without a beneficiary designation. Further, they will post reminders on their participant website and might produce special mailings for those participants lacking a beneficiary designation, encouraging them to follow through on this front. From anecdotal experience, the success rate of these campaigns is marginal at best, as it is targeting the same individuals who had to be auto enrolled in the plan because they wouldn’t take the time to join.
The real problem here is the common misconception among plan sponsors that they and their recordkeeper are in this beneficiary problem together. A quick read of the typical service agreement from most recordkeepers shows the following:
• The recordkeeper will take direction from the plan sponsor and participant regarding the beneficiary designation but has no ownership of that process.
• As they have no ownership/responsibility for the beneficiary election, the recordkeeper has no liability for any problems in this arena.
• The plan sponsor, as part of the conversion process when the move to this recordkeeper was undertaken, owns the responsibility for the accuracy of data transferred to the recordkeeper as part of that conversion—including existing beneficiary designations.
When a recordkeeper makes an error regarding an existing, valid beneficiary election that they are charged with processing, its disclaimers do not apply. However, the lack of a beneficiary designation is, in the view of the recordkeeper, not their issue.
Plan Participants Are Still Living, for Now
The lack of a valid beneficiary was a growing problem even before auto enrollment caught on. The culprit, which has grown in strength over the past 15 years, is the Internet. Participants who enroll in their 401(k) plans online are not required to complete a beneficiary election. This leads to the next significant reason that missing beneficiary elections in 401(k) plans have not yet created an outcry: Most of these participants are alive.
401(k) plans are roughly 30 years old, but most of their uptake has occurred within the past 20 years. The Internet and online enrollment have been commonplace for about 10-12 years. Auto enrollment is an even newer practice that wasn’t embraced until the 2006 passage of the Pension Protection Act.
There are many employers who are missing beneficiary elections for 30-40 percent of their participant population. Most of these employers have never offered auto enrollment. Their missing elections came about the old-fashioned way (missing paper beneficiary election forms and missing online elections).
The issue of missing or disputed beneficiary forms has caused some plan sponsors a fair amount of pain and expense, but the larger bubble for this issue will burst when the Baby Boomer generation dies. Primarily, those that are missing beneficiary designations because of auto enrollment are the youngest members of the workforce. These individuals won’t be retiring for anywhere from 30 to 50 years and will likely live another 20 to 30 years from that point.
'Boilerplate' Language Isn't Enough
This brings up the final reason that the lack of a beneficiary form has not yet been identified as a widespread issue: the belief that boilerplate "missing beneficiary" language in the plan document will handle this situation. While in some cases this will prove to be true, life will likely prove to be a bit more complex than boilerplate language can address—particularly when it involves 401(k) accounts left at former employers that might sit dormant for 50 years. Here are a few of the challenges that reality will introduce:
• While many of those auto enrolled will enter a plan unmarried, roughly 70 percent of the workforce will join the married ranks at some point.
• Unfortunately, somewhere between 40 and 50 percent of marriages will end in divorce; 75 percent of those that divorce will remarry, with 65 percent of those marriages ending in divorce.
• If they have children, the average number of children per family is a little less than two. For the dormant, 50-year-old account, it’s likely that the married participant’s children will themselves have children by the time the participant is deceased.
• A study of the U.S. Bureau of Labor Statistics found that the typical worker had on average 10 jobs before the age of 42.
• Different states have different laws regarding retirement accounts without beneficiaries, although pre-emption of state law by the Employee Retirement Income Security Act (ERISA) might limit some of the confusion in this area. What are the odds that the 23-year-old workers just auto enrolled into a 401(k) plan move a few times between now and the time they attain age 65?
Aggressive Approaches Might Be Needed
The U.S. Supreme Court in the 2009 case of Kennedy v. Plan Administrator for DuPont Savings and Investment Plan cited the ERISA provision that “employee benefit plans are to be established and maintained pursuant to a written instrument … specifying the basis on which payments are made to and from the plan.” Under the Kennedy case, the plan document controls who should receive the death benefit in the absence of a proper beneficiary designation.
It seems reasonable that most plan participants would prefer designating a beneficiary as opposed to the plan provisions controlling the designation. Moreover, in the event that there is a surviving spouse, ERISA section 205 requires that a participant’s account balance be “payable in full to the participant’s surviving spouse (or, if there is no surviving spouse or the surviving spouse consents in the manner designated under ERISA, to a designated beneficiary).
In summary, a single auto-enrolled participant with no stated beneficiary might create a number of interested parties with different ideas about who ultimately should receive the proceeds. The recordkeeper who auto enrolled the participant initially might have been replaced several times by the time the participant (or the participant’s beneficiaries) appears to claim benefits. In any event, the responsibility for determining the proper beneficiary, and any costs associated with making or defending that choice, remain with the plan sponsor.
Paper is by no means perfect, but there does appear to be a case for considering the old-fashioned approach of requiring a completed beneficiary election in writing with a completed enrollment form. Those using electronic and, in particular, auto enrollment should consider aggressive approaches to obtain beneficiary designations—and/or to encourage ex-employees to roll assets out of the plan before their demise.
Michael A. Abbott is a partner with Gardere and primarily practices in the areas of employee benefits including ESOPs and executive compensation. Marshall J. Cobb, CRSP, is president and founder of Cobb Retirement Solutions LLC, an independent, fee-only firm offering qualified plan analysis and oversight exclusively to corporations and organizations.
Beneficiary Designation: General Form, SHRM Templates and Tools
Family Feuds: The Battles Over Retirement Accounts, Wall Street Journal, September 2011
Most U.S. Employers Opt for 'Passive' Open Enrollment, SHRM Online Benefits Discipline, August 2011
401(k) Automatic Enrollment: Does It Help or Hurt Savings?, SHRM Online Benefits Discipline, July 2011
Misplaced Enrollment Form Creates ERISA Liability for Plan Sponsor, SHRM Online Benefits Discipline, May 2011
Retirement Plans: Former Employees Can Be Current Problems, SHRM Online Benefits Discipline, July 2010
Retirement Plan Sponsors Should Keep Track of Former Employees, SHRM Online Benefits Discipline, February 2009
Divorce, Non-Spouse Beneficiaries and the Pension Protection Act, SHRM Online Benefits Discipline, September 2006
Communicating Benefits Information Online, HR Magazine, January 2001
SHRM Online Benefits Discipline
SHRM Online Retirement Plans Resource Page