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The Basics of Automatic Plan Design

The Basics of Automatic Plan Design

Some of the biggest hurdles to plan participation are inertia and choice overload. Automatic plan design features, such as automatic enrollment, automatic deferral escalation, automatic rebalancing and Qualified Default Investment Alternatives (QDIAs), help employees overcome these obstacles and take advantage of the retirement plan benefits. 

Because participants are automatically enrolled into a default investment option at a set deferral rate, they do not need to make the decisions themselves.

Some plan sponsors are hesitant to implement automatic plan design features because they fear that their employees will push back; however, research shows that automatic plan design features resonate significantly with employees. Automatic plan design features attract more employees to participate in the plan and can help participants better prepare for retirement.

Automatic enrollment

Plan sponsors can implement automatic enrollment for any plan that allows elective deferrals. Automatic enrollment enables plan sponsors to automatically deduct elective deferrals from an employee’s salary into a retirement account. If plan sponsors automatically enroll employees into the retirement plan, they must give employees the option to either opt out of the plan or change the deferral amount before any automatic contributions begin.

Types of automatic enrollment

The Department of Labor (DOL) allows for a variety of automatic enrollment arrangements, which allows plan sponsors to determine the best option for their participants.

  • Automatic Contribution Arrangement (ACA)
    In this basic type of automatic enrollment, employees are automatically enrolled in the plan unless they elect otherwise. The default automatic deferral amount is specified in the plan document. Participants have the option to either not contribute or to contribute a different percentage of pay.
  • Eligible Automatic Contribution Arrangement (EACA)
    In an EACA, the plan’s default deferral percentage is applied uniformly to all employees after distributing the appropriate notice. This type of arrangement 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)
    Like an EACA, a QACA uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice. Additionally, this arrangement meets additional “safe harbor” provisions that exempt the plan from annual actual deferral percentage and actual contribution percentage nondiscrimination testing requirements. A QACA requires that the default elective deferral percentage starts at 3 percent and gradually increases to 6 percent with each year that an employee participates. Unlike the other types of automatic enrollment arrangement, QACAs require employer contributions. Plan sponsors may choose:
  • Matching contributions: 100 percent match for elective deferrals that do not exceed 1 percent of compensation, plus 50 percent match for elective deferrals between 1 and 6 percent of compensation
  • Non-elective contribution: 3 percent of compensation for all participants, including those who choose not to make any elective deferrals.
  • Employees must be 100 percent vested in the employer’s matching or non-elective contributions after no more than two years of service

Plan may not distribute any of the required employer contributions due to an employee’s financial hardship.

Re-enrollment

When implementing automatic enrollment, plan sponsors must first decide whether to enroll only new employees or new employees and existing employees. Additionally, plan sponsors should determine whether they want to automatically enroll all employees at the beginning of each benefit year; therefore, requiring employees who do not want to participants to have to actively opt out of the plan on an annual basis.

Automatic deferral escalation

In addition to automatic enrollment, plan sponsors also may use automatic deferral escalation. This feature enables plan sponsors to automatically increase the amount of participants’ elective deferrals by a certain percentage on an annual basis. Plan sponsors typically choose to automatically increase deferral rates by one to two percentages per year. The plan document will specify a cap for the automatic deferral escalation.

Default Investment Option

In 2006, the Pension Protection Act (PPA) paved the way for automatic plan design by providing for safe harbor for plan sponsors that adopt these features. Specifically, the PPA allows for a Qualified Default Investment Alternative (QDIA), which is a default investment option for participants who are automatically enrolled into a plan.

Four types of QDIAs are permitted by the PPA:

  • A lifecycle or target-date fund
  • A professionally managed account or investment service that allocates contributions among existing plan options that takes into account the participant’s age or retirement date
  • A balanced fund that offers a mix of investments that take into account the characteristics of the group of employees as a whole
  • A capital preservation product for only the first 120 days, which may reduce the administrative burden for plan sponsors if employees decide to opt out of participation.

As a general rule, QDIAs may not invest participant elective deferrals in employer securities. QDIAs give participants a place to invest their money without having to make complicated investment and asset allocation decisions.

Conclusion

You can adopt the level of automatic plan design that works best for your plan and your participants. Ultimately, any level of automation takes the burden off the participants and helps clear the barriers to enrolling in the plan and preparing for the future.

NOTES: Provided content is for overview and informational purposes only and is not intended as tax, legal, fiduciary, or investment advice.

Web Content Viewer (JSR 286)

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NOTES: Provided content is for overview and informational purposes only and is not intended as tax, legal, fiduciary, or investment advice.

Web Content Viewer (JSR 286)

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