Replacing Mandatory Employee Contributions with Automatic Enrollment
While mandatory contributions are a necessity in defined benefit plans to ensure proper funding, I have never been a proponent of them in defined contribution plans, except when they serve as the only way to make pre-tax contributions to a qualified retirement plan (such as 414(h) pickup contributions for money purchase plans). Otherwise, these mandatory contribution formulas, most of which were implemented long before automatic enrollment existed, seem to be dinosaurs - similar to after-tax contributions following the arrival of Roth.
And the marketplace, for what it is worth, appears to agree, as employee mandatory contributions (other than in 414(h) pickups) are rarely seen outside of one particular sector: college and university 403(b) plans. However, in these higher education organizations, there are many plan sponsors who still utilize mandatory contributions, and relatively few who have adopted automatic enrollment (and, if they have adopted automatic enrollment, they often do so in addition to the mandatory contributions). Now that a number of universities are reducing or suspending their employer contributions, due to the COVID-19 pandemic, they are beginning to question the logic of requiring employee contributions.
But simply removing the mandatory employee contribution is a “double whammy,” in terms of the destruction of retirement security. No or little employer contribution + no employee contribution = retirement disaster, especially for younger employees, due to the power of compounding. Instead, these employers should consider replacing their employee mandatory contribution with automatic enrollment. In automatic enrollment arrangements, employee contributions to the plan are effectively preserved and employees can opt out for any reason.
Now, 403(b) employee mandatory contributions do have one key advantage over automatic enrollment: if mandatory contributions are made as a condition of employment or pursuant to a one-time irrevocable election as to whether to participate in the plan, then the contributions do not count against the 402(g) elective deferral limit of $19,500/$26,000. Thus, those who can afford to do so can make their maximum elective deferrals in addition to their 403(b) mandatory contribution.
However, with the high retirement plan contribution limits, particularly where 403(b) plans are paired with a 457(b) (as detailed in a recent Top of Mind) - which is the case at many higher education institutions - few individuals are truly maxing out to the point where taking away their mandatory contribution “freebie” would be a detriment. And, considering that these individuals can afford to defer such huge sums of money to their retirement plan probably means that the employee mandatory portion is an extremely small slice of their retirement pie. Thus, generally, the benefits of automatic enrollment far outweigh this one drawback.
Plan sponsors should do their homework to review participant data to ascertain how many individuals are indeed “maxing out” over and above their mandatory contribution. If there are a lot of employees who fit this description, perhaps automatic enrollment is not the right decision. This might also be a sign that employees are bumping up against their 415 limit on total contributions, which may warrant consideration of alternative designs, such as pairing a 401(a) with a 403(b). However, for the majority of 403(b) plan sponsors currently utilizing a mandatory contribution formula, auto-enrollment is likely a viable option.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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