Automatic Enrollment: How It Works and What SECURE 2.0 Changed

How a plan enrolls employees has a large effect on whether they save. In a traditional plan, employees have to take action to join. Many mean to, and many never get around to it.

Automatic enrollment flips the default. Eligible employees are enrolled at a set contribution rate unless they choose otherwise. Research on retirement plans has consistently found higher participation when enrollment is automatic, largely because people tend to stay with whatever default is in place.

How it works

The basic sequence looks like this:

1. An employee becomes eligible for the plan.
2. The employee receives a notice explaining the default contribution rate, the default investment, and how to opt out or choose a different rate.
3. If the employee does nothing, payroll begins withholding contributions at the default rate.
4. Contributions are invested in the plan's default investment, usually a qualified default investment alternative (QDIA) such as a target date fund.
5. The employee can change or stop contributions at any time.

Three types of arrangements

There are three common forms of automatic enrollment, each with its own rules.

Automatic contribution arrangement (ACA). The most flexible version. The plan sets a default rate and follows its notice requirements, without the extra features of the other two types.

Eligible automatic contribution arrangement (EACA). Requires a uniform default rate for everyone covered. In exchange, employees can request a refund of their automatic contributions within 90 days of the first deferral, and the plan gets extra time to correct failed nondiscrimination tests.

Qualified automatic contribution arrangement (QACA). A safe harbor version. The plan follows a minimum default contribution schedule and makes a required employer contribution, either a match of 100% of the first 1% of pay deferred plus 50% of the next 5%, or a 3% nonelective contribution. QACA employer contributions can be subject to vesting of up to two years, and the plan is treated as passing the ADP and ACP nondiscrimination tests.

The SECURE 2.0 requirement for new plans

The SECURE 2.0 Act made automatic enrollment mandatory for many new plans. For 401(k) and 403(b) plans established after December 29, 2022, beginning with plan years that start after December 31, 2024, the plan must:

• Automatically enroll eligible employees at an initial rate of at least 3% and no more than 10%
• Increase that rate by 1% each year until it reaches at least 10%, up to a maximum of 15%
• Allow employees to withdraw automatic contributions within 90 days
• Invest contributions in a qualified default investment alternative unless the employee chooses otherwise

Several groups are exempt, including plans established before December 29, 2022, businesses with 10 or fewer employees, businesses in existence for less than three years, church plans, and governmental plans.

Choosing a default rate

Historically, many plans defaulted employees at 3%. Because employees tend to stay at the default, a low starting rate can anchor savings lower than many employees would choose on their own. Many sponsors now start at a higher rate and pair it with automatic escalation, which raises the rate gradually over time. The right starting point depends on your workforce, your budget for matching contributions, and how employees are likely to respond.

Cost considerations

Automatic enrollment usually means more participants. If your plan includes a match, more participants means more matching contributions. Before adopting it, model the expected cost under a few participation scenarios.

Two related design choices are worth discussing at the same time:

• Vesting. A vesting schedule on employer contributions can reduce the cost of contributions for employees who leave early, within the rules for your plan type.
• Small balances. Automatic enrollment can create many small accounts for short-tenure employees. Plan provisions for small balance distributions and automatic rollovers help keep those accounts manageable.

New hires only, or everyone?

Sponsors can apply automatic enrollment to new hires only, or they can run a one-time sweep that enrolls current eligible employees who are not participating. A sweep reaches more people at once but adds cost and requires careful communication.

Operational requirements

Automatic enrollment works only if the mechanics work. Plans need accurate eligibility tracking, timely notices before enrollment and each year after, coordination between payroll and the recordkeeper, and a reliable way to record opt-outs and rate changes. Mistakes do happen, and the IRS correction programs include a simplified approach for automatic enrollment errors that are caught and fixed promptly, although the employer still owes any missed matching contributions.

Want a second look at whether automatic enrollment fits your plan? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm meets with business owners to review plan design. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

Can employees opt out of automatic enrollment?

Yes. Employees can opt out or change their contribution rate at any time, subject to the plan's administrative procedures.

Does our existing plan have to add automatic enrollment?

Plans established before December 29, 2022 are not required to under SECURE 2.0, though they can choose to adopt it.

What happens to contributions if an employee opts out after a few weeks?

In an EACA, the employee can request a refund of automatic contributions within 90 days of the first deferral. Otherwise, the money stays in the plan subject to the plan's distribution rules.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.