Some employers are using automatic or simplified enrollment in defined contribution plans to boost participation rates.
McDonald's Corp., Oak Brook, Ill., which boasts a 95% participation rate, has been using automatic enrollment in its $535 million 401(k) plan since 1994.
Others that have reportedly considered automatic or simplified enrollment include J.C. Penney Co., Plano, Texas; H.J. Heinz Co., Pittsburgh; ITT Corp., New York; and Intermountain Health Care, Salt Lake City.
Under automatic enrollment, an employee is a member of a plan and a contribution is automatically deducted from his or her pay unless he or she specifically asks not be in the plan. The contribution usually is set aside in a stable value or company stock fund; the employee then can redirect the money to other options.
Under simplified enrollment, the employer determines a minimum default percentage to be set aside and each new hire is enrolled during orientation by signing a form agreeing to the contribution rate and allocation. The participant can select a different contribution rate, allocate the contribution differently or opt out at that time.
The big appeal is high participation, without the protracted process of encouraging and cajoling through extensive communication programs.
Because it could help a plan pass non-discrimination tests, automatic or simple enrollment appeals to firms with a low percentage of eligible non-highly compensated employees participating in the plan.
Despite the advantages, some experts warn automatic enrollment, also known as negative election, could raise legal questions.
Said Dennis Coleman, partner at The Kwasha Lipton Group, Fort Lee, N.J.:
"There may be legal issues with negative election by withholding a portion of an employee's salary without them knowing about it. With negative election when the employees become eligible, they automatically come in at a certain reduction in pay unless they make the election not to participate. They may find themselves participating in a plan they never elected to participate in."
Mr. Coleman said Kwasha favors the simplified enrollment process, in which the new hire is asked at the time he is hired to sign an enrollment form and "affirmatively elects to participate at a certain percentage of pay."
Another potential problem is compliance with 404(c) guide-lines, Mr. Coleman said.
Section 404(c) guidelines reduce fiduciary responsibility in participant-directed plans that have adequate diversification and that provide a "safe harbor" option such as a money market or guaranteed investment contract fund.
He said the guidelines state a plan sponsor can't claim 404(c) protection "unless the employee is offered the opportunity to choose among funds . . . With negative election he hasn't had the opportunity to choose."
Henry Saveth, principal at Foster Higgins, Washington, said another issue is whether the Internal Revenue Service will "consider this a valid (method of) election."
Mr. Saveth said it is "unlikely" employers using automatic enrollment will receive a "hard and fast" legal approval. The automatic enrollment process, he said, is "pretty much in a gray zone because there is nothing which says you can't do it."
"Some employers find a safeguard position is to cite the method in their plan documents when they send them to the IRS for approval. The IRS hasn't formally blessed it, but if the plan highlights it in the cover letter and if the IRS sends a favorable letter, it's not conclusive but it can bolster your case," he said.
Even though automatic enrollment has yet to gain widespread acceptance among plan sponsors, there is evidence that some form of the process might help build participation rates.
In a report conducted last year for CIGNA Corp. to determine factors that lead to higher levels of participation, Access Research Inc., Windsor, Conn., found 70% of the 401(k) plans with participation rates of more than 80% required employees to decline through a written form, while only 55% of plans with participation rates of less than 80% had the same requirement.
BEI Electronics Inc., San Francisco, evaluated automatic enrollment but currently uses a variation of simplified participant enrollment that William T. Aber, director-human resources, calls "pressing them" to participate.
He said BEI has attained a 92% participation rate by presenting new employees a deferral form agreeing to contribute 2% of their salary when they become eligible to participate in the $67 million 401(k) plan.
The plan consists of four passively managed funds, according to Mr. Aber.
"We push them," said Mr. Aber. "We tell them all the advantages of the plan and then have them sign up for 2%. We inform them that they can get out of the plan. And, if they don't want to participate in the plan, they must say so in writing . . . The time to do all this is at the time of hiring, we really press them," he said.
Gary Blank, a San Francisco benefits consultant, said automatic enrollment "makes some sense."
Most employees, he said, don't understand the tax advantages of a 401(k). They also "don't recognize their pay doesn't go down as much as they think it will when they contribute," he said. "Through negative election, an employee may see that it is not so bad after all."
A McDonald's spokesman agreed, saying its automatic enrollment program leads to "inertia," whereby "the employee gets a few statements and sees how much has built up and becomes interested in the plan."
McDonald's provides new employees with a package outlining the plan before the eligibility date and starts with a 3% deferral rate and a fully vested match in company stock.
The employee can choose not to join the plan, but otherwise is enrolled automatically.
"When the company put in the 401(k) it was felt the plan should be operated in the best interests of the participants and beneficiaries. If handled correctly, the participant is not harmed. He is fully vested and may opt out at any time," said the McDonald's spokesman.
"The company is not taking anything away: The assets belong to the participant, the assets are always there and he may get out whenever he wants. It helps people who should be saving, the younger employee."
But the McDonald's official acknowledged such a system creates more work for its in-house record-keeping operation because records must be maintained "on a lot of small accounts."
Still, he said, "We feel it is a good method of helping people save for retirement. People who have opted out continue to receive quarterly statements and see even small amounts grow consistently, and frequently decide to get back into the plan."