If you are a plan sponsor of a defined contribution (DC) retirement plan, I m sure you have heard the term "automatic enrollment" and I m sure you have been encouraged by your consultants or advisors to consider it for your DC plan. If you haven t already added it, you may be sitting there saying to yourself: Automatic enrollment, why not? It's automatic, therefore it will save time, improve plan participation, and allow us to focus on other priorities. Done. Simple. If you have already added it, I m sure you re reading that last statement and saying to yourself, Yes, I thought the same thing.

I m not writing to put the kibosh on this design. Quite the contrary. Automatic enrollment has its place and I have recommended it to clients when the pros and cons of adding automatic enrollment were evaluated in the context of the overall design and goal of the employer. But let me be clear on this: unless you are an employee of an auto-enrollment plan that takes absolutely no initiative, there is nothing automatic about auto enrollment.

As a plan sponsor, it is crucial to identify goals. Whether it is improving participation, improving discrimination results, or perhaps improving the benefits to a key set of employees, the goals identified will help to guide design considerations. And if one of these considerations is automatic enrollment, you should be aware of the following:

First, your options: ACA, EACA, and QACA

When adding an automatic enrollment design to your plan, you must choose which type of arrangement you wish to have, in writing, within your document. In short summary, the choices are:

Automatic contribution arrangement (ACA):

• Employees are automatically enrolled in the plan unless they elect otherwise
• Plan document specifies the percentage of wages that will be automatically deducted
• Employees can elect not to contribute or to contribute a different percentage of pay

Eligible automatic contribution arrangement (EACA):

• Same as ACA, plus:
• May allow employees to withdraw automatic contributions, including earnings, within 90 days of the date of the first automatic contribution

Qualified automatic contribution arrangement (QACA):

• Employees are automatically enrolled in the plan unless they elect otherwise.
• Employees can elect not to contribute or to contribute a different percentage of pay.
• Meets additional "safe harbor" provisions that exempt the plan from annual actual deferral percentage (ADP) and actual contribution percentage (ACP) nondiscrimination testing requirements.
• Default deferral percentage starts at 3% and gradually increases to 6% with each year that an employee participates. The default percentage cannot exceed 10%.
• Required employer contributions. Pick one of either:
  • Matching contribution: 100% match for elective deferrals that do not exceed 1% of compensation, plus 50% match for elective deferrals between 1% and 6% of compensation.
  • Nonelective contribution: 3% of compensation for all participants, including those who choose not to make any elective deferrals.
• Employees must be 100% vested in the employer's matching or nonelective contributions after no more than two years of service.

Second: Additional responsibilities and potential pitfalls

As a plan sponsor you must provide a notice within a reasonable time, before any deferrals are withheld from wages, to allow employees the option of electing not to contribute or to have a different amount withheld. You will also be responsible for making sure the deductions are entered into your payroll system in a timely manner per your plan's eligibility rules. A review of your eligibility provisions is essential as they may impact the notice requirements and your internal new hire enrollment process.

You must choose an investment for employees automatically deducted salary deferral contributions. You can limit your liability for plan investment losses by choosing default investments for deferrals that meet certain criteria for transferability and safety, such as model portfolios, target funds/models, or balanced funds. This is referred to as a qualified default investment alternative (QDIA) and, again, your employees must be given a required notice and an opportunity to change the investment choice. It is important to note that these are two separate notices and they are both required 1) initially, and 2) annually. However, they may be combined to simplify creation and mailing.

You have the option of choosing whether or not to apply this new feature to all existing employees or only to new hires. If you have a matching component to your plan, you can and should expect your costs to increase. A simple way to review the cost impact would be to look at your prior-year census and deferral data. Then apply a default percentage to the group that would have been brought in who did not defer a single dollar to the plan. Then apply your match formula.

Your audit will become more extensive. Additional provisions require additional monitoring to ensure you are in compliance with your plan document. For example, the auditor's sample population will be expanded to include those auto enrolled. You may be asked to verify the timing of notices, the actual timing of the auto-enrolled participant deferrals, and the direction of their default investments. If there is oversight or neglect, the employer will be required to correct the failure by making a corrective payment to all the participants overlooked or auto enrolled later than what was required by your plan's eligibility provisions. The correction requires the employer to pay each participant account half of the amount the employee would have contributed plus the full amount of match they would have received (if applicable), accounting for potential investment earnings or losses.

Last: Complacency

Historical behavior trends within auto-enrolled plans demonstrate a tendency towards complacency from the participant, an I don t have to do anything, so why should I type of mentality. As an example, a survey of plan sponsors conducted by Asset International indicates that over 50% of plans using auto enrollment use a default deferral rate of 3%. A client I work with has this same provision and, in a recent analysis, we determined that, of those auto enrolled, only 4% actually opted out. That is great in terms of the number of employees participating in the plan. However, over 60% of these individuals remained at the default deferral rate. When we compared this to the remainder of the client's population, we found that over 75% of the employees who had voluntarily enrolled were contributing over 5%. What is the takeaway? If they had to make an election to defer, they most likely would have elected something greater than the 3% and most likely chosen investment allocations better suited to their risk tolerances and time horizon for retirement planning.

The complacency we have witnessed can be combated by automatic increase provisions and/or communication and education initiatives. The automatic increase provision was strongly supported by the Pension Protection Act of 2006 and this design is one way of battling complacency. But it also adds complexity and monitoring in the administration of the plan.

Automatic enrollment is a solution but only one of the many that should be considered as you try to achieve your goals with your retirement plan.