Automatic, Not Autopilot: Managing 401(k) Plans in the Auto-Enrollment Era

When employers received the go-ahead to automatically enroll employees into 401(k) plans, it seemed that a game changer had arrived. With 401(k) plans rapidly becoming the sole retirement savings vehicle for the majority of employees, employers had been concerned about the retirement prospects for those employees who did not take the important step of enrolling in the plan.

Automatic enrollment, often accompanied by an automatic deferral of some percentage of pay and an automatic escalation of those deferrals over time, can help alleviate this concern, even if it does not solve the problem entirely. Indeed, 401(k) plans with automatic enrollment have seen a significant increase in participation. Data from a 2023 survey of profit-sharing and 401(k) plans conducted by the Plan Sponsor Council of America (PSCA) showed that automatic enrollment can increase participation rates by 15 percentage points or more depending on plan size.

Moreover, participation gains are concentrated in demographic groups that can benefit the most from plan participation. A study of the U.S. military’s efforts to increase retirement savings found that automatic enrollment has the greatest impact on participation among people who are young, nonwhite, unmarried, or have not attended college.

Given that these individuals have been shown to be at higher risk of experiencing disparities in retirement savings and wealth accumulation, it is fair to say that automatic enrollment helps those who need it most. This finding is backed up by other studies. For example, Vanguard’s How America Saves 2023 report found participation rates among younger workers and workers earning less than $50,000 to be 30 to 50 percentage points higher in plans with automatic enrollment.

Clearly, auto-enroll features have been a net good for participants who need to save for retirement and build long-term wealth. Plan sponsors that want to offer robust retirement benefits (and, in the process, meet the requirements of nondiscrimination testing) also benefit.

However, plan sponsors should still be aware of potential issues that can arise as 401(k) plan participation becomes more automated. This primarily occurs when plan participants are not fully engaged with the plan because they don’t need to take action to participate. The good news is that it is well within the plan sponsor’s power to minimize these issues.

Nurture Engagement, Not Passivity

The strength of automatic enrollment, deferrals, default investments, and contribution escalation is that plan participants do not have to make decisions. When all these features are present, participants don’t have to decide whether to enroll in the plan, how much pay to defer into the plan, how to invest that money, or when and how much to increase deferrals over time—that is, unless they choose to make these decisions.

If plan sponsors are not careful, this reality can create a sort of passivity among plan participants in regard to retirement savings. When this type of passivity takes hold, the impact can be lasting and particularly problematic if employees change jobs.

“People who make elections to defer money [into the 401(k) plan] are making a decision to put money into plan,” said John Lowell, a partner with October Three Consulting in Woodstock, Ga. “When these people change jobs, they tend to be more committed to leaving the money in a retirement plan,” rather than cashing it out. This is often less true with those who were auto-enrolled into the plan, he noted.

Research bears this out. Participants who were automatically enrolled in a 401(k) plan “are significantly more likely to take a cash distribution (and potentially pay a tax penalty) than those separating from jobs with voluntary enrollment plans, offsetting some of the benefits from automatic enrollment,” according to a study published in the Journal of Pension Economics & Finance. However, the researchers noted that the assets lost through this leakage are not high enough to offset the wealth that participants overall gain from automatic enrollment.

The message for plan sponsors is that automatic features are not an end in themselves. Instead, they should be the beginning of a conversation about the importance of saving for retirement, how participants can make the most of the plan, and how assets can build over time with a long-term commitment to saving.

Focusing on the Long Term

Asset loss does not just happen when plan participants change jobs. In some cases, plan participants may simply forget about the plan and their assets, particularly in plans with automatic enrollment for which they do not have to take an active role in retirement savings.

Research by academics and government officials found that automatic enrollment increases the chance that participants will abandon their accounts, even after they retire. The study used tax data to quantify retirement assets that had not been claimed more than 10 years after participants had reached the age when they would be subject to significant penalties if they did not take required minimum distributions of those assets. An “analysis of state unclaimed property databases suggests that workplace defined contribution plans are abandoned at a higher rate than IRAs … [and] certain accounts created by default enrollment are at higher risk of abandonment by passive savers,” according to the study. The value of these accounts totaled $66 million.

There may be little that plan sponsors can do for former plan participants a decade or more after they retire. However, ongoing communication can help participants engage with their retirement savings and learn about options for long-term management of these assets.

This can include information about automatic rollovers for accounts with $7,000 or less in assets and, for larger accounts, employee options for maintaining the tax deferral of their assets either by leaving those assets in the former employer’s plan or rolling those assets over into a new employer’s plan or an IRA. A growing consortium of retirement plan service providers that have banded together to standardize and automate the rollover process can also be an important resource for plan participants.

Design Automatic Features Carefully

Perhaps the most important element of any plan with automatic features is ongoing management.

“I’m an advocate of auto-features, but plan sponsors can’t expect to implement these features and then leave them alone,” said Richard Reed, Boston-based vice president and defined contribution practice director at Segal. “They need to be managed.”

This management can include everything from the level of automatic deferrals and deferral escalation to ongoing communication about the plan and its automatic features. For example, it is essential that deferral levels and any escalation features adhere to the realities of participants’ lives. If deferral levels are too high or escalation occurs too quickly and/or with steps that are too high, participants could end up with financial problems.

For example, if automatic deferral escalation absorbs too much of employees’ annual pay increases, that could lead to dissatisfaction with the plan at best and cause financial hardship for employees at worst. If more participants start opting out of the plan, taking out plan loans, and applying for hardship withdrawals, that is a good indication that something may need to change.

Another way to avoid overtaxing employees is to add an emergency savings account feature to the retirement plan. This feature allows employees to make after-tax contributions to use in an emergency rather than tapping retirement plan assets.

The employer sponsoring the plan must also avoid overextending itself through automatic plan features. Given how much enrollment and, by extension, matching contributions increase after implementing automatic features, it is important that these changes be sustainable.

“Be prepared because the plan could reach 100 percent participation” after implementing automatic enrollment, Reed said. “Look at plan design and census data to see how things will play out under different match scenarios to understand potential maximum cost.”

Not surprisingly these costs are a key reason why some plan sponsors, and not just small firms, avoid automatic features. The PSCA survey found that many plan sponsors, especially the largest ones with 5,000 or more participants, forgo automatic enrollment because of concerns about plan costs.

“No one wants to take things away,” Reed said. “You can always add more later.”

Joanne Sammer is a freelance writer based in New Jersey.