The challenge

A manufacturing client has a low participation rate in its 401(k) plan, with more than half of its employees choosing not to participate. As a result, it has problems passing nondiscrimination testing each year. Highly compensated employees (HCEs) have expressed their desire to defer what they want and not have deferrals returned due to failed nondiscrimination tests.

Outside of the plan, the company also struggles with higher-than-normal turnover rates and, in fact, over the past two years the client had over a 20% turnover rate each year, which also impacts participant retirement savings.

The client offers an employer matching contribution of 50% up to the first 6% deferred in the 401(k) plan. The matching contribution has a six-year vesting schedule, which is not commonly seen in the manufacturing industry.

The client hasn’t provided its employees with any retirement plan education meetings for several years. Employees lack the necessary education needed to make the right decisions for their retirement plan savings.

Milliman solution

1. Offer automatic enrollment and automatic escalation

Based on the actual average deferral percentage (ADP) test and the average contribution percentage (ACP) test results for the last three years (see the table in Figure 1), the HCEs’ average deferral rate increased by 1% annually. However, the average deferral rate of the non-highly-compensated-employees (NHCEs) had little change over the last three years. Using 2022 test information, the data indicates the NHCEs’ average deferral rate needs to increase by at least 2.4% to pass the ADP test.

Plan design is the primary change maker—to alter participant behavior, design the plan so employees must take action to make decisions that would lead to less optimal outcomes. In this case, the most effective way to increase participation rates as well as the average deferral rate is to add automatic enrollment or autopilot plan features.

As with any element of plan design, there are important items to consider when using automatic enrollment and escalation.

In many scenarios, automatic enrollment only applies to new hires. However, for this plan Milliman recommended a one-time reenrollment for anyone contributing less than the plan default deferral rate, including participants not deferring.

Milliman evaluated the potential benefits and costs from both the employees’ perspective and the company’s perspective. To help the client understand the cost impact by using different automatic enrollment default rates, Milliman used the client’s latest annual census data and provided the cost estimate analysis by illustrating the scenarios shown in Figure 2.

2. Shortened vesting schedule

Milliman also recommended shortening the vesting schedule to make the company matching contribution more attractive to its employees. Industry trends¹ show over 90% of plans with employer matching contributions use shorter than six-year vesting schedules and 50% of plans have immediate vesting. In this highly competitive job market, immediate vesting can be attractive to potential candidates during the recruitment process.

3. Provide effective participant communication to engage employees

To help employees reach the desired retirement savings outcome, Milliman encourages employee education and communication to ensure the plan is well-utilized and appreciated. A solid communication program not only helps inform employees of plan benefits but also encourages participation. Communicating employee benefits also helps with retention as employees gain an understanding of the economic value of benefits beyond their pay.

The outcome

In partnership with Milliman’s detailed analysis and expertise, the client was able to make the following plan design changes in its 401(k) plan:

1. Automatic enrollment at a 2% default rate plus 1% automatic escalation up to 6%.
2. For employees who currently defer less than 6%, the plan added a one-time reenrollment:
   • Employees who had 0% deferral rates followed the automated program for new hires of a 2% default rate plus 1% automatic increase up to 6%.
   • Employees with current deferral rates between 1% and 5% had an annual 1% automatic increase up to 6% added.
3. To attract and retain employees, the plan’s vesting schedule was also shortened. The six-year graded vesting schedule was changed to an immediate vesting schedule.

Below is the employee communication program adopted:

• The client engaged Milliman to prepare clear and concise materials that explain plan features, upcoming plan design changes, and the importance of saving for retirement. The information is easily accessible for employees through multiple channels—such as web, email, direct mail, posters, etc.
• The client communicated the plan design changes during the all-staff meeting, which gave the top management an opportunity to provide more in-depth, thorough explanations of the plan, eligibility and contribution features, and other important facets of plan participation.
• The client offered employees in-person support from the Milliman retirement education team and dedicated human resources (HR) representatives.

At the end of the reenrollment window, 96% of employees stayed at the default rate and 99% of employees kept to the automatic escalation schedule. Based on these results, the client achieved all their initial goals:

1. Increased participation rate: With the new automated features also offered to existing participants, the plan immediately doubled the participation rate from 42.5% to 83.7%.
2. Improved retirement outcomes: Employees who otherwise may have chosen not to save are now automatically set to contribute and take advantage of the company match. This will help them save more toward retirement. The sooner the better when it comes to retirement savings, so automatically enrolling employees when they first start is a great way to help them build their retirement savings.
3. Improved nondiscrimination testing results: Prior to implementing automatic enrollment, most nonparticipating employees were NHCEs, which led to the average contribution rate for NHCEs being lower, limiting the amount that HCEs and key employees can contribute to the plan. Automatically enrolling employees into the plan along with annual automatic escalation improves NHCEs’ average deferral rates and ultimately can improve nondiscrimination testing results.
4. More engaged employees: These plan design changes had a very positive impact on current employees and the client’s ability to recruit new employees with a competitive retirement program. Studies have also linked financial well-being with on-the-job performance and employee retention. The new retirement program contributes to their overall financial well-being.

¹ Vanguard. How America Saves Report 2023.