First, consider the goals of your plan. Do you want to increase participation, raise contribution rates, or get employees to recognize the value of your plan? Do you want to improve nondiscrimination testing results, or do away with testing altogether? Would it be easier if you allowed higher-paid employees to contribute more? Most importantly, do you want to help your employees save enough to secure a comfortable retirement? If so, adding automatic features to your 401(k) plan makes sense.
Next, evaluate the elements of an automatic 401(k). Automatic enrollment is the key element of this stage. You’ll need to decide whether or not to enroll all employees, or just new hires. Experience shows that greater participation gains and positive responses from employees are more likely when both groups are included.
Then, you’ll need to consider a default contribution rate. Many companies have used 3 percent as their default contribution rate but research shows that many employees would consider saving at a higher rate. A common practice is to set your deferral rate to align with employer matching contributions, if offered.
Once you’ve established a default contribution rate, you’ll need to consider whether to increase this amount each year an employee stays with the company. This is referred to as automatic escalation and can be an important tool to help employees save enough for a secure retirement. You can automatically increase the deferral rate each year at any time you desire, such as at the end of the calendar or fiscal year.
Finally, you must select a default investment fund. Many participants remain in a default investment rather than make their own selection. Therefore, a common approach is to choose default investments, such as lifecycle or balanced funds, designed to outpace inflation over the long-term and optimize the relationship between risk and return. The Department of Labor has expressed the view that a default selection that is too conservative over the long-term, such as a money market fund, could keep employees from earning enough return on their investment to provide the retirement income they desire.
What to learn more? Read "How to Implement an Automatic 401(k) Plan and Increase Employee Contributions"