When McDonald’s Corp. launched its 401(k) in 1984, it took an unusual step to ensure that enrollment was high. Instead of nagging employees to join the plan, the company simply signed them up itself. McDonald’s claimed 3 percent of pretax compensation and put the money in company stock, unless employees specifically requested otherwise. Today McDonald’s reports that 93 percent of all eligible employees participate in the 401(k).
This kind of automatic enrollment became increasingly popular among corporate sponsors, especially after the Internal Revenue Service officially endorsed the practice in a 1998 ruling. When Hewitt Associates surveyed Fortune 500 companies in 1999 and again in 2001, the firm found that the number using the automatic arrangement had doubled over the two-year period, to 70, of about 400 companies that responded to the survey. Many plan sponsors assumed that this was an effective strategy to bring more workers into the plan and thus meet federal regulations that try to ensure that lower-paid employees get access to retirement benefits comparable to that of top executives.
But early this year McDonald’s dropped automatic enrollment. And while no other companies are known to have thrown out the program, the appearance of new plans has clearly slowed, experts say.
“Two years ago every client wanted to take a look,” says Richard Koski, a principal at Buck Consultants. “But only a few put it in. It probably got far more press than utilization.”
Automatic enrollment programs aim to make participating in a 401(k) an intrinsic part of employment, like getting a company ID. Typically, people are logged into the plan , entailing a small paycheck deduction and a basic asset allocation , shortly after they are hired.
Not surprisingly, most people don,t bother to opt out once they,ve been enrolled. Participation rates in plans with automatic enrollment tend to reach about 85 percent, versus 75 percent for the average plan, according to the Profit Sharing/401(k) Council of America and Hewitt.
Of course, that’s good news for corporate sponsors. However, a number of unexpected problems have cropped up.
For starters, many benefits officials are troubled by the whole premise of having such a heavy corporate hand in a retirement plan supposedly based on personal choice. For that matter, in light of the Enron Corp. scandal, employees may not be so willing these days to trust their employers to make investment decisions for their 401(k)s. Then there are practical issues.
Automatic enrollment is usually used only for new hires. That means if personnel turnover is low, there won,t be a significant increase in the level of participation. Yet if turnover is too high, the hassle and expense of administering a constant barrage of tiny new accounts can be daunting.
Plan sponsors are also finding that participants rarely budge from the conservative investment options their employers typically choose for them. Companies make those choices because they seem the most prudent , and most responsible in a fiduciary sense , but they will probably be too conservative for most participants and certainly less profitable than more aggressive investment choices for providers that manage the plan portfolios.
In addition, some sponsors are concerned that auto enrollment may conflict with state laws regarding involuntary deductions from paychecks. That’s because these laws, in states such as California and New York, require that employees must affirmatively decide to have any money taken out of their paychecks by their employer.
"[Automatic enrollment] seems to have plateaued,” concludes David Wray, president of the Profit Sharing/401(k) Council of America. “There were companies that were quite set to do it,” he adds, which have since backed off.
Case in point: a leading software solutions company based in the Philadelphia area. It considered implementing automatic enrollment to hike its participation rate, which is now in “the low 80s,” says a benefits official there. But the company worried about sending a mixed message. “Philosophically, we like employees to take charge of their own personal business. If we do something that,s mandatory, is that consistent with our practices?” And benefits executives feared that six months or a year from the plan’s start employees might start to say things like: “I don,t want to contribute. I can,t believe you did that. It wasn,t clear in the orientation.”
Partly to avoid such resentment, most companies automatically enroll only new hires, typically explaining to them in their initial orientation that money will be deducted from their paychecks but that they have the right to opt out. “We just felt it would be too intrusive to retroactively go back [and enroll current employees]. People might interpret that as punitive,” explains Sharon Silver, senior vice president for human resources and benefits at publisher Pearson, which just started automatic enrollment this year for new employees.
Of course, since companies haven,t been doing a lot of hiring in the past year, limiting automatic enrollment to new staffers hasn,t had much impact on their participation rates.
But even a hiring flurry might not be a solution, especially for companies in high-turnover industries. “You end up with a lot of small account balances for people that don,t exist. They leave, they move, they don,t tell you where they are,” says the Profit Sharing Council’s Wray. He says last year’s tax law eased some of the burden by allowing employers to roll each orphaned 401(k) into an individual retirement account and then turn the whole account over to outside managers. Still, Joe Hessenthaler, a principal at consultant Towers Perrin, estimates that the extra administrative hassle costs plans an average of $100,000 a year.
Most experts believe that turnover , a chronic problem in the fast-food business , was the reason McDonald’s threw up its hands on automatic enrollment. However, a spokeswoman for McDonald’s says that was not an issue for the $1.8 billion plan. Rather, she says, the decision to drop automatic enrollment was part of a “holistic, integrated look at our plan” that also included increasing the company match from 3 percent to 4 percent and letting participants change their investments daily rather than monthly. “Certainly,” she adds, “one of the secondary or tertiary benefits is that [the revised system] is simpler from an administrative perspective.”
Probably the most publicized problems for employers are the low contribution rates and ultraconservative investment strategies used in setting up the plans. Because they don,t want workers to scream that their paychecks are being decimated, plan sponsors tend to take out only 3 percent of pay as the default deferral rate , half the typical rate of people who sign up voluntarily. Similarly, fearful of being sued for fiduciary irresponsibility, plan sponsors pick the most conservative options on their menus as the automatic investment allocation. In the Hewitt survey, 68 percent chose a money market or stable value fund.
Then inertia kicks in. Employers have discovered that people who aren,t going to take the initiative to join a 401(k) are also not going to take the initiative to change the contribution rate or asset allocation selected by their employer. “People sort of take what you give them,” says Arne Lemke, Pearson’s director of defined contribution and share plans.
Automatic enrollment may not spread to many new plan sponsors, but no one expects the practice to disappear. “We are definitely hoping that automatic enrollment will be back on the radar screens of employers, because we think it does a great job of increasing participation over time,” says Lori Lucas, a defined contribution consultant at Hewitt.
Some of the problems may be easily solved. For instance, Lucas says companies should be more aggressive and make their default deferral rate whatever is needed to qualify for the company match , typically, 6 percent. Instead of money market and stable value funds, they should make the default investment a lifestyle or balanced fund, which would offer more diversification and presumably greater returns without undue risk.
As a halfway measure, Lucas also endorses the new “Smart” savings plan devised by UCLA accounting professor Shlomo Benartzi (Institutional Investor, December 2001), which combines both voluntary and involuntary elements. In this plan employees promise in advance to put a certain percentage of any future pay raises in their 401(k).
Cigna Corp., which installed automatic enrollment for new hires in August 2000, has a fairly high 20 percent turnover rate among its staff of 40,000. That’s probably why participation has climbed to 75 percent from an initial 68 percent. As a financial services firm, Cigna has a built-in solution to the problem of all those little accounts the ex-employees leave behind: “Our business gets a chance to turn them into IRAs,” says Gerald Meyn, vice president of employee benefits and health management.
Automatic enrollment may turn out to be a niche product that works only in certain industries, like finance. Retailers and restaurant owners, with their low pay and heavy turnover, might be ill-suited for automatic enrollment programs. A better target may be businesses with well-educated, highly paid staff and already strong participation rates.
For now, many companies are going back to basics to get their participation rates up , they,re doing more to educate their employees about the value of a 401(k). The Philadelphia software company, for one, has put in a new communication program and offers financial planning seminars. “A year, 18 months out, if we,re still at the same (participation) level and we,re not making any dent, we would really have to look at automatic enrollment,” says the benefits official. But then he adds, “We would have to assess whether our employees would accept it.”
