(401)k by force Featured

9:59am EDT July 22, 2002

In 1998, the IRS decided to allow employers the right to automatically enroll employees in 401(k) programs. Is this the answer to increased employee retirement plan participation? Simply put, probably not.

This tactic may appeal to small business owners who have fewer employees and a poor participation rate in the plan. However, such a move will probably build resentment from those forced to participate.

Still, here are some of the benefits of such a program:

  • It does boost participation in your 401(k) plan.

  • It reduces the likelihood that the plan will fail nondiscrimination tests.

  • It allows you to enroll lower-paid employees, who typically don’t plan for retirement, into the program.

But while all of this is well and good, you could risk losing one of your most valuable resources in the process: your employees.

The way the required participation feature works is that if employees don’t specify an amount they want to contribute or don’t elect to stay out of the program, you can automatically reduce their salaries by 3 percent, which goes into their 401(k) plans. Employees must be told annually what percentage is diverted from their pay and they then have the option of changing that percentage.

In addition to building resentment, this required participation does nothing to educate employees about the purpose behind saving for retirement or why such a program is implemented. Keep in mind that one of the purposes of establishing a 401(k) program is to give employees the power to make their own investment decisions. Without a proper investment education program, mandatory contributions could cause even more resentment.

A good investment education program should have three main components: good content, good explanations and frequent education sessions. Many companies run their investment education programs at specific times during the year, usually during plan enrollment, retirement or termination of employment, or upon request by employees.

A better way to enhance participation in a 401(k) plan to match a portion of whatever employees contribute, say 50 cents for every dollar they contribute up to 6 percent of their salaries.

The bottom line on mandated participation is that, even though it’s approved by the IRS, its likely effect on your employees makes it a poor option. Perhaps that’s why so few employers have required participation to date.

Louis P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a fee-only North Hills Securities and Exchange Commission registered investment advisory firm that provides asset management and comprehensive financial planning services to individuals and businesses. Its Web site is at www.legend-financial.com.