Should Your Plan Include Auto-Enrollment and Auto-Escalation?

Setting up a 401(k) plan is only half the battle—getting employees to participate is the real challenge. Many workers don't sign up because they forget, procrastinate, or don't understand the benefits. That's where auto-enrollment and auto-escalation come in.

These features automate retirement savings, making it easier for employees to build their financial future while helping employers improve plan participation and compliance. But are they right for your business? Let's break down the benefits, compliance rules, and real-world impact.

What Is Auto-Enrollment?

Auto-enrollment means new employees are automatically enrolled in the company's 401(k) plan at a default contribution rate unless they actively opt out.

Instead of requiring employees to take action to join, auto-enrollment flips the script: they're in by default unless they choose otherwise.

How It Works

• New hires (or eligible employees) are automatically enrolled at a set percentage—typically 3% to 6% of their salary.
• Contributions go into a default investment, often a target-date fund or a balanced fund.
• Employees can adjust their contribution rate or opt out if they choose.

What Is Auto-Escalation?

Auto-escalation automatically increases employees' contribution rates over time, usually by 1% per year , until they reach a set limit (often 10-15%).

How It Works

• Employees start at the default rate (e.g., 3%).
• Each year, their contribution increases (e.g., by 1%) until they reach a pre-set cap.
• Employees can opt out or change their increase rate at any time.

Why Employers Use Auto-Enrollment and Auto-Escalation

1. Higher Participation Rates

Many employees intend to join a 401(k) but never get around to it. Auto-enrollment removes that barrier. Studies show that participation jumps from 50-60% to 85-95% with auto-enrollment.

Auto-escalation further boosts savings, helping employees reach the recommended 10-15% contribution rate for a secure retirement.

2. Better Retirement Outcomes for Employees

Employees often under-save for retirement. Auto-escalation helps by gradually increasing contributions without employees feeling the pinch.

For example:

• If an employee starts at 3% and increases by 1% per year, they'll hit 10% in just seven years—without ever feeling a sudden financial strain.

3. Improved Compliance with IRS Nondiscrimination Testing

401(k) plans must pass IRS nondiscrimination tests, ensuring that highly compensated employees (HCEs) aren't benefiting more than lower-paid employees.

If not enough non-highly compensated employees (NHCEs) participate, your plan may fail testing, leading to refunds and compliance headaches.

Auto-enrollment helps increase lower-paid employees' participation, making passing these tests easier.

4. Eligibility for Safe Harbor 401(k) Status

If your plan struggles with compliance testing, you may consider a safe harbor 401(k). Auto-enrollment is a key feature in some safe harbor plans, ensuring full participation while avoiding IRS testing.

5. Attracting and Retaining Talent

Employees see retirement benefits as a key part of a compensation package. Offering auto-enrollment and auto-escalation makes your company more competitive—especially as more employers adopt these features.

Compliance Rules for Auto-Enrollment and Auto-Escalation

Auto-enrollment and auto-escalation must follow IRS and Department of Labor (DOL) rules.

1. Types of Auto-Enrollment Plans

Employers can set up auto-enrollment in different ways:

• Basic Auto-Enrollment (ACA) – Employees are automatically enrolled at a set percentage (e.g., 3%), with the option to opt out.
• Eligible Automatic Contribution Arrangement (EACA) – Same as ACA but allows employees to withdraw contributions within 90 days of enrollment.
• Qualified Automatic Contribution Arrangement (QACA) – A safe harbor version of auto-enrollment with required employer contributions and automatic escalation.

2. Contribution Limits and Caps

• The default contribution rate is usually 3-6%, but plans can set it higher.
• Auto-escalation typically stops at 10-15%, though some plans allow higher limits.

3. Notice Requirements

Employers must provide annual notices informing employees of:

• Their auto-enrollment status
• How to change their contribution rate
• How to opt out

The Pros and Cons of Auto-Enrollment and Auto-Escalation

Pros

✔ Increases participation: More employees save for retirement.

✔ Boosts retirement savings: Auto-escalation helps employees reach their goals.

✔ Easier compliance: Reduces the risk of failing IRS nondiscrimination tests.

✔ Attracts and retains employees: A competitive benefit in today's job market.

✔ Encourages financial wellness: Employees save without needing to take action.

Cons

✘ Higher employer costs: More participants may mean higher matching contributions.

✘ Administrative complexity: Requires monitoring, notices, and compliance reporting.

✘ Employee resistance: Some employees dislike automatic deductions from their paychecks.

Should Your Business Use Auto-Enrollment and Auto-Escalation?

It depends on your company's goals.

✔ If you want to improve participation rates and compliance – Auto-enrollment is a great solution.

✔ If you want to encourage long-term savings – Auto-escalation ensures employees increase their contributions over time.

✔ If you want a hassle-free 401(k) plan – A QACA Safe Harbor 401(k) with auto-enrollment can eliminate compliance testing.

However, if your business is worried about cost or has a workforce resistant to auto-deductions, you may want to start small—offering auto-enrollment at a lower rate and gradually increasing it.

The Bottom Line

Auto-enrollment and auto-escalation remove the biggest barrier to retirement savings: inaction. They help employees build wealth effortlessly, improve plan compliance, and make 401(k) plans more effective.

If you're an employer, contact us today to implement a strategy that balances participation, compliance, and cost.

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