Data shows that automatic features, such as automatic (auto) enrollment, auto-increase, and re-enrollment can significantly improve participation rates and help employees save for retirement.1 Explore cost-neutral ways of adding such auto features to your plan design.
A recent survey revealed that 69% of employers say it’s their responsibility to help employees save for retirement.2 One of the simplest things they can do is add automatic features such as auto-enrollment, auto-increase, and re-enrollment sweep to the plan design. Without these, plan sponsors could inadvertently put retirement out of reach for some employees. However, many employers are concerned about the cost of adding auto features to the plan. The good news is there may be cost-neutral ways to go about it.
How does auto-enrollment remove impediments to employee savings?
As employer-sponsored retirement plans have moved from defined benefit to defined contribution plans, employees not auto enrolled must make the choice to start saving in the retirement plan. This has led to a significant number of employees eligible but not participating in their retirement plan.
of eligible employees are not participating in their workplace retirement plan3
Auto-enrollment can help get employees started saving sooner
How much would someone age 40, just starting to save for retirement, need to defer to save enough to replace 80% of pre-retirement income?
In a recent Principal® survey, the average age of those not participating in their retirement account is 40.* If they begin to save today, they will need to defer a significant portion of their income to make up the shortfall.
To replace 80% of income, an employee earning $150,000 at age 64 can expect to replace approximately 25% of their income through Social Security. In retirement, they would then have to draw down the additional 55% from retirement savings or $82,500 to replace 80% of their pre-retirement earnings. This requires an employee enrolling for the first time to defer:
- 12% of income over 35 years if enrolling at age 30.
- 20% of income over 25 years if enrolling at age 40.
- 40% of income over 15 years if enrolling at age 50.
* Principal® Retirement Security Survey—Nonparticipants, December 2023.
All calculations assume $0 beginning balance, 6% investments return, salary increase of 2.5% annually, retirement age of 65, 30% replacement from Social Security based on salary, inflation is 2% and the annual income from the 401(k) account balance is based on a 4.5% withdrawal rate adjusted annually for inflation. SSN source: https://www.ssa.gov/OACT/quickcalc/
Auto-enrollment might be the nudge many employees need to start saving for retirement. Its use can help determine if an employee will start saving, keep saving, or save enough for a successful retirement. When a plan implements auto features, participation rates are nearly 40% higher than plans without the auto feature.4
Can auto-enrollment reduce enrollment confusion?
Employees don’t just want the nudge auto-enrollment provides—they assume it. In a survey, 65% of employees said they expect to be auto enrolled in a workplace retirement plan when starting a new job.5
The survey also asked employees why they weren’t participating in their employer-sponsored retirement plan—59% mistakenly thought they were participating. Of those, nearly half thought they were auto enrolled.6
By embracing auto-enrollment, plan sponsors can help curb confusion and get employees on their retirement savings journey.
Why auto-increase should be paired with auto-enrollment?
I’ve heard many participant stories in my tenure consulting with plan sponsors on retirement plans. The most heartbreaking is when participants feel they did “all the right things” throughout their careers, yet their account balances came up extremely short at retirement. In some cases, they were auto-enrolled but never increased their contribution percentage beyond the default deferral rate.
Plan sponsors can help change these stories by implementing auto-increase, or what some call auto-escalation. Here, the plan is designed to increase the participant’s deferral rate by at least 1% each year until it reaches a cap set by the plan, typically around 15% when including the employer match. This would set participant contributions to industry-suggested deferral rates at which they are more likely to save enough to replace 70%-85% of their pre-retirement income.7
Why a 401(k) re-enrollment sweep increases participation
Auto-enrollment and auto-increase are best practices to help increase participation and deferral rates, but some employees can still fall through the cracks.
- Participants who initially opt out of auto-enrollment and are never asked again to participate in the retirement plan.
- Those who stop contributing for one reason or another but forgot to re-enroll.
- Those deferring less than the default deferral rate set by the employer.
By annually re-enrolling all non-participants into the plan and increasing the deferral rate for those contributing less than the default rate, plan sponsors can help participants get back on track for retirement. With re-enrollment, employees can still opt-out if they are still not ready to participate. But it allows them to make the conscious decision to delay saving for retirement for another year.
Can auto features be added without increasing costs?
The potential cost of auto features is often the reason we hear from plan sponsors for not adopting these best practices in plan design. But cost doesn’t have to stand in the way. It’s possible to accommodate the budget while incorporating auto features into the plan. Here are a couple of ways:
Tax credits
As we’ve shown, auto features work to help employees get into the plan and save enough for retirement. Yet nearly 80% of small businesses, those with less than 50 employees, don’t implement, citing cost as the reason.8
That’s why in the SECURE Act of 2022 (SECURE 2.0), Congress included tax credits for not only starting a retirement plan, but for implementing automatic enrollment and employer-matching contributions. These tax incentives can help small employers make it more affordable to start a plan and incorporate auto features.
Find more details about the tax credits, including a worksheet to help calculate the possible tax credits. It’s always wise to consult with your tax advisor for all the details.
Redesign the plan
When cost is a concern, it might be time to make some changes to the plan design. It’s encouraged to reassess the current plan formula, asking:
- What are the goals for the retirement plan?
- Is it a shared responsibility for funding the retirement plan, or should it be weighted toward the employee?
- Why do you have the current formula?
- What is the budget as a percentage of compensation?
In these discussions, plan sponsors should review costs, not only measured by the bottom line, but indirect cost from high turnover, loss of high-demand skills, and cost to recruit positions left unfilled, as well as cost of delays in retirement. All this can cost the organization in various ways. A plan redesign can help address the cost of automatic features in a cost neutral manner and help meet the goals and objectives the plan sponsor has for providing a retirement plan.
The future of retirement and auto features
Eighty-eight percent of financial professionals and 76% of employers believe that automatic enrollment features will be required within all employer-sponsored retirement plans by 2030.9
The need to redesign plans for automatic features may come sooner than many realize. SECURE 2.0 contains a provision requiring that most new 401(k) and 403(b) plans include automatic enrollment with an annual auto-increase of at least 1%.10 It’s not a far stretch to believe that auto features will likely be required in all retirement plans in the future.
Discover more retirement research and insights
Find the latest on plan design, retirement legislation, and pension plans from Principal® thought leaders. Uncover additional ways to use the retirement plan as an incentive that works for your business and helps your employees save more. Get more insights.
It’s important to work with a retirement service provider who understands retirement and has the expertise to consult on options to help deliver your desired results. If you’re looking for options that could work in building a more robust retirement plan—reach out to your Principal representative.
