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When employees are automatically enrolled in 401(k) plans the company tab can soar.
Russ Banham, CFO Magazine
July 15, 2008
Companies with 401(k) plans that suffer from lagging enrollment rates and flagging investment performance now have powerful tools to help turn things around, but they may find that fixing those problems comes at a price.
Under the Pension Protection Act of 2006 (PPA), plan sponsors can now automatically sign up employees in defined-contribution (DC) programs, boost the amount of salary that workers defer, and make plans default to specific investment options — presumably those that offer higher returns than money-market funds.
Those moves bode well for employees, many of whom, experts say, have not been saving enough for retirement. But as more employees take part, employers may find themselves shelling out substantially more money in matching contributions, and administrative costs may mount. The toll is likely to be most significant at large companies. "Will the match considerations dissuade some companies from offering automatic enrollment?" asks Leslie Smith, senior vice president and Northeast practice leader of the defined-contributions group at Aon Consulting. "If you have 4,000 employees in the plan and add 50, that won't have much impact on the budget. But adding tens of thousands of employees would take a huge chunk of change."
In with the In Crowd
While automatic enrollment per se is not new, the law clears up confusion in some states about whether employers can sign workers up in employer-provided DC plans without their written consent. Previously, certain state laws denied plan sponsors that opportunity. The automatic-enrollment provisions of the PPA, which became effective on January 1, also permit companies to slot employees' 401(k) investments into such programs as target-age retirement funds that alter the investment risk as workers age.
Under the PPA, employers can automatically place workers in a 401(k) without their written authorization. The effect is to make inertia work in favor of 401(k)s: although participants have 90 days to opt out of the plan and get a refund, few do. After implementing automatic enrollment in January, TRI-AD, an Escondido, California-based provider of benefits administration, has seen its plan-participation rate take off from 80 percent to 94 percent of the company's 100-plus employees. Unless they opt out in writing, TRI-AD employees must automatically defer 3 percent of their salaries to the 401(k), which the company matches 40 cents on the dollar.
"Of the employees that were automatically enrolled in the plan, only one opted out and was provided a refund," says CFO Bob Krier. "There was virtually no backlash. Apparently, when someone takes care of retirement savings for employees, they let them."
Assessing the Costs
For some companies, however, the costs can be prohibitive. According to a Hewitt Associates survey of 190 companies, greater dollar matches were cited as the primary impediment to automatic enrollment by nearly half the companies that did not intend to adopt the practice in the near future. Pam Hess, Hewitt's director of retirement research, estimates that a company that automatically enrolled all its employees in a plan would hike the amount it spent in matches by 20 to 30 percent. Put another way, a typical Fortune 1,000 company that boosts participation from the current average of 72 percent to 90 percent would spend an additional $17.6 million a year in matching contributions. Presumably that's a major reason that a December 2007 Vanguard survey of 50 plans with automatic-enrollment provisions found that 90 percent of the plans are adopting them for new hires only.
Another, though less significant, demerit to automatic enrollment might be an increase in administrative costs. That sets up another choice for employers: Should they charge those costs back to participants — thereby diminishing their retirement savings — or should they eat those costs themselves? Retirement-plan record-keepers and third-party administrators typically provide invoices to plan sponsors for their services on a per-participant basis. Aon's Smith says this cost can be charged back to the participant, as long as it is reported transparently (which is itself a contentious issue; see "Courting Disaster," May).
Automatic-enrollment plans also pose a special penalty risk: companies that don't provide timely notices to employees regarding their automatic enrollment can be hit with a fine of $1,100 per day by the U.S. Department of Labor (DoL). "You have to tell employees that within 30 days money will be taken from their paycheck and invested unless they inform you otherwise," says TRI-AD vice president of compliance Judy Simons.
Balanced against the advantages of increased plan participation, those caveats haven't deterred many employers from automating 401(k) enrollment. A survey of 1,100 companies conducted earlier this year by Aon found that 30 percent currently offer it and another 23 percent expect to offer it in the next two years. Jeff Fick, vice president of human resources at RLI Corp., a Peoria-based specialty-lines property-and-casualty insurer, says the burdens of the provision have been light. "The drawbacks are nonissues for us," he says. "This is a good thing, and over time will become routine."
Another enhancement, if implemented correctly, is a DoL provision issued under the PPA that allows employers to be less risk-averse in terms of the investment choices they offer. The provision relieved employers of their fiduciary liability to employees who pick options that perform poorly.
Many plan sponsors have traditionally provided a menu of investment choices heavy on fixed-income, stable-value options, believing the safe course was to help participants preserve capital. Cognizant that such options breed low returns, the DoL issued rules in September 2006 that relieved employers of their fiduciary responsibilities as long as worker 401(k) contributions are invested in a Qualified Default Investment Alternative. The QDIAs must be highly diversified portfolios and must not contain employer securities among the mix of investments. Sponsors are limited to three investment types — balanced funds, lifestyle or targeted funds, and managed accounts. "If an employee is defaulted into one of these investments, there is greater potential investment growth, and they have someone managing their money for them," says Robyn Credico, national director of defined-contribution consulting at Watson Wyatt Worldwide.
Regardless of where a company channels employees' funds, more companies seem interested in default enrollment. At Land O'Lakes Inc., a $10 billion dairy and agricultural cooperative, participation has gone from 70 percent to 93 percent, according to Bob Tomaschko, director of compensation, retirement, and human-resources management systems. The company enrolls employees at 5 percent of their salaries in order to receive the company's maximum 4 percent match. The goal, Tomaschko says, was not simply to provide the maximum match, but to "help employees achieve the required savings rates in order to have the income they will need at retirement."
Russ Banham is a contributing editor of CFO.