Exploring Automatic Enrollment and Automatic Escalation

Types of Auto-Enroll Plans, Auto-Enroll as a Best Practice, Advantages of Auto Escalation, etc. 

While retirement plans are the primary long-term savings vehicle for most Americans, there are several ways to incentivize employees to participate in their company-sponsored plans. For example, Auto-enrollment is often considered the easiest and most effective way to maximize retirement savings. With auto-enroll, employees will automatically make contributions to their plans at a specified default rate unless they make an affirmative decision to either contribute at a different rate or opt-out.

Types of Auto-Enroll Plans

Auto-enroll plans come in several forms:

  1. Basic Automatic Enrollment (also referred to as Automatic Contribution Agreement, ACA)  Employees are automatically enrolled in the plan unless they elect otherwise. The plan document specifies the percentage of compensation that will be automatically deducted. Employees can choose to contribute a different percentage of pay.

  2. Eligible Automatic Contribution Arrangement (EACA)  These plans are similar to the Basic Automatic Enrollment plans, but the plan’s default deferral percentage is uniformly applied to all employees. If a plan contains an EACA, an auto-enrolled employee can opt out and request the return of their automatic salary deferrals no less than 30 and no more than 90 days after the first salary deferral. An EACA can allow automatically enrolled participants to withdraw contributions within 30-90 days of the first contribution.

  3. Qualified Automatic Contribution Arrangement (QACA) — QACAs are like EACAs for safe harbor plans. QACAs have a minimum default deferral percentage, as well as a minimum and maximum auto-escalation percentage. QACAs require that the employer contributes either a 3% non-elective contribution or matches 100% of the first 1% of compensation deferred and 50% of deferrals that exceed 1% of compensation, not to exceed 6% of compensation with a required vesting schedule for employer contributions of up to 2 years.

Auto-Enroll As a Best Practice

The underlying principle behind auto-enroll is to harness the power of inertia for good. Automatically enrolling participants has proven to dramatically increase plan participation by eliminating the need for employees to take action on their own. In fact, auto-enrolling employees have shown plan participation rates of over 90%, far surpassing the 28% mean participation rate for opt-in plans. Automatic enrollment also increases the reach of retirement plans, making younger employees, women, minorities, and lower-paid employees more likely to participate. It’s also worth noting that thanks to the SECURE Act, any small plan that implements automatic enrollment in 2020 or later is eligible for a $500 tax credit for three years. This applies to both existing and new plans and can be combined with the tax credit for new plans of up to $5,000 for additional savings.

Typical vs. “Ideal” Auto-Enroll Percentages

The default percentage for automatic enrollment can range from 2% to 7%, with 3%-6% deferral rates being the most common. Among employers whose plans offer automatic enrollment, the average default deferral rate is 3.4% nationwide. For QACAs, the default deferral percentage must begin at 3%. That said, employees should strive to put aside at least 10% of their annual pay for retirement.

Incorporating Auto-Escalation

While defaulting employees to a 10% auto-enrollment contribution might be out of the comfort zone for many, automatic escalation (or auto-escalation) can help employees get there. With auto-escalation, an employee’s deferral increases each year at predetermined intervals – typically, an employee’s contribution amount will increase by 1% every year until it reaches its pre-set maximum. As with auto-enroll, participants can opt out at any time. A plan sponsor can choose the appropriate maximum escalation percentage for its plan, either the plan’s maximum possible deferral percentage or a lesser percentage. A reasonable maximum escalation percentage could range from 10-15%. For QACAs, the deferral percentage gradually increases to 6% with each year an employee participates. The default percentage cannot exceed 10% for the first year of participation, but it can be as much as 15% after that.

Advantages of Auto-Escalation

Auto-enroll and auto-escalate pair well together. When employees are automatically enrolled at a set salary deferral rate, they are less likely to increase their contributions over time, even as their income increases. In other words, retirement plans with only an auto-enroll feature may have high participation rates, but these participants may not be contributing enough of their salary toward retirement. In fact, a recent survey showed that one-third of participants with an auto-escalate feature reported saving more than 10%. By contrast, for plans without auto-escalate, only one-fifth of participants had savings rates of over 10%. While it’s important for plan sponsors to make the best decisions for the plan, there is compelling data to encourage auto-enrollment and auto-escalation features. Auto-enroll puts employees on a path to retirement from the moment the plan starts, while auto-escalate helps them reach their ideal contribution rates, sometimes without even feeling an impact.