Automatic enrollment has been around since the late 1990s, but it never really gained traction until the passage of the Pension Protection Act of 2006, which states auto-enrollment is permissible so long as employees are given the opportunity to elect not to contribute and provided with an initial and annual notice describing how they can revoke the automatic salary deferral.

But despite this guidance, employers still remained concerned about to two other issues: how various state laws would affect “unauthorized” payroll deductions and how employee contributions should be automatically invested.

PPA also cleared up those two issues and encouraged automatic enrollment by:

• Pre-empting state law to allow employers to automatically enroll employees without written consent.

• Adding two new types of automatic enrollment: eligible automatic contribution arrangements and qualified automatic contribution arrangements.

• Providing fiduciary relief to plan sponsors for the investment of employees’ contribution if invested in a qualified default investment arrangement.

Here is a brief overview of the auto-enrollment alphabet soup:

EACAs

An EACA works basically like this:

1. Employers enroll eligible employees in the 401(k) plan at a uniform contribution rate.

2. Employers may choose to provide for an automatic annual increase in the deferral percentage.

3. Contributions are invested in a qualified default investment alternative.

4. Employers may refund 401(k) contributions to employees who do not want to participate, but failed to opt out within 90 days after automatic enrollment began.

5. Employers have up to six months after the end of the plan year to make any corrections to pass 401(k) discrimination tests, rather than the normal 2 1/2 months.

QACAs

If a plan is set up as a QACA with certain minimum levels of employer and employee contributions, it is exempt from annual 401(k) discrimination testing. In essence, it makes another safe-harbor contribution option available to employers.

In order to take advantage of this new safe harbor, the employer must meet the EACA rules described above and comply with two other requirements:

1. The initial automatic enrollment amount must be at least 3% (but not more than 10%) of compensation and must annually increase this amount to at least 4% in the second year, at least 5% in the third year, and at least 6% in the fourth year and thereafter.

2. The employer must make a safe-harbor contributions that must be 100% vested after two years of service as either:

• A contribution of 3% of pay for all eligible employees, even if they are not contributing to the plan.

• A matching contribution of 100% of the first 1% deferred, plus 50% of the next 5% deferred, or a maximum of 3.5% of compensation.

Increased participation

So how has automatic enrollment worked out since the passage of the PPA? Studies have shown that it has increased plan participation from a national average of approximately 75% of eligible employees to between 85% and 95%. Dramatic increases have been seen among groups of employees with the lowest participation rates.

Until now, employers have focused automatic enrollment on new hires. The next generation of automatic enrollment is to enroll existing employees who are not in the plan. It can be a powerful way to help these employees save for retirement.

Even amid the recession, a recent Hewitt survey of about 150 midsize and large employers indicated that automatic enrollment increased from 44% in 2008 to 51% this year. However, among employers that don’t use automatic enrollment, 25% plan to adopt it for new hires, and 15% are likely to adopt it for existing employees in 2009. This is down from 57% and 27%, respectively.

But the slower rate of growth of automatic enrollment was caused by more than just the economic recession. Some employers are waiting for regulations that have been delayed in the new administration’s transition.

And what about the approximately 50% of employees who have no employer-sponsored plan at all? That issue is going to be part of the upcoming political debate, as mandating auto-enrollment was included in the first version of President Obama’s budget. Stay tuned.

Contributing Editor Jerry Kalish is the founder of The Retirement Plan Blog and president of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm.