Tuesday, September 27, 2016

Automatic enrollment and testing

An automatic enrollment program generally is described as an arrangement in which

  • employees who fail to make an affirmative election within the specified time frame are treated as having made a “negative consent” election to defer a percentage of compensation as specified in the plan;
  • participants have the opportunity to make a deferral rate change or to stop deferrals altogether, even after being automatically enrolled;
  • participants may be subject to an automatic increase feature, which would increase their deferral percentage each year.

How can an automatic enrollment program improve testing results?

Elective deferrals are subject to the actual deferral percentage (ADP) test, which compares the average deferral percentage contributed by the highly compensated employees (HCEs) to the average deferral percentage contributed by the nonhighly compensated employees (NHCEs). Generally, the average deferral percentage of HCEs cannot exceed that of NHCEs by more than two percent.

If a plan isn't able to pass the ADP test, the HCEs aren't able to contribute as much as they'd like because the NHCEs' average deferral rate is too low. Adding an automatic enrollment feature can improve test results because it may increase the number of NHCEs participating in the plan, and thereby increase the NHCEs' average deferral percentage, lessening the differential between the average deferral rate of the HCEs compared to the NHCEs.

Can an automatic enrollment program be added to a plan mid-year?

Possibly. There are two types of automatic enrollment programs that can help improve testing results—the automatic contribution arrangement (ACA) and the eligible automatic contribution arrangement (EACA). An ACA can be added to a plan at any time (e.g., mid-year), whereas the EACA can only be added to a plan at the beginning of a plan year.

Is there a maximum or minimum automatic elective deferral rate an employer may establish?

Although three percent is a common initial automatic deferral percentage, there is no statutory or regulatory maximum or minimum on the percent an employer may elect. However, if the goal is to use an automatic enrollment program to improve testing, the automatic elective deferral rate should be set at a rate that is high enough to accomplish that goal, yet at a rate where employees won't immediately opt out.

While some employees will opt out of the automatic enrollment program, the majority tend to continue to defer at the rate in which they were automatically enrolled.

How can including an automatic increase feature further improve testing results?

For plans in which an initial automatic deferral rate can't be set at a rate high enough to pass the ADP test, implementing an automatic increase feature can further improve testing results over time. An automatic increase feature increases employees’ elective deferrals each year up to a predefined limit—for example, increasing elective deferrals by one percent per year up to a maximum deferral rate of 10 percent. This can help participants more adequately save for retirement.

Contact your Vanguard Retirement Plan Access Client Service Team if you have questions regarding automatic enrollment and testing.