Auto enrollment to Roth 401(k)

[JRN]

401(k) Plan provides for automatic enrollment. The idea is to automatically enroll participants in either a Roth or traditional (pre-tax) 401(k) account depending on the participant's wages. If the participant earns less than $45K annually, the participant will be automatically enrolled in Roth. If the participant earns more than $45K, the participant will be automatically enrolled in a traditional (pre-tax) 401(k) account.

The reasoning here is that employees who earn $45K or less do not generally pay any Federal income tax (e.g.,after taking into account the Retirement Savings Contributions Credit), so enrolling them in a Roth 401(k) makes more sense for them.

Seems interesting. Any thoughts on this idea?

[mphs77]

If I am a participant and you want to automatically enroll me, but not provide me with

a tax savings in this automatic enrollment; when my boss Jane can get a tax savings

with her automatic enrollment; seems faulty to me.

But then again, I still believe Social Security will be there for me when I hit 66 and 10 months....

[hr for me]

I wouldn't want to be the one making tax decisions and consequences based solely on an employees wages. You never know what their 1040 income looks like in other earnings/spouse's earnings etc. I think it is a flawed reasoning personally to guess that they generally don't pay any federal income tax. To me, this is too close to giving tax advice.

But I don't tend to like auto-enroll although I've done enough non-discrimination testing in my lifetime to understand the purpose.

[Mike Preston]

Isn't the rationale irrational? Why in the world would you want those with lesser tax rates to be given an "includes less taxable" benefit? If my tax rate is low then I get maximum advantage from income. If my tax rate is high, I want as much excluded from tax as I can arrange. Something is whack here.

[JRN]

Mike, here is the thinking on this: If the employee is paying zero federal income taxes, why would he/she want to make 401(k) contributions as traditional "pre-tax"? The income tax deduction that generally accrues to the participant does the participant no good. If I am a lower wage employee and my current income tax rate is -0- today, shouldn't I make my contributions as Roth contributions? That's the rationale.

[Mike Preston]

I grant that Roth, in part, is better for those who can accurately predict a future which involves higher tax rates. As has been mentioned already, there is no way to reliably correlate low earnings from this one person at this one employer to a low current tax rate. Hence why it should always be left to the participant to decide.

I still think there is something fundamentally inconsistent in play. If I accept the above approach (that it is better to contribute Roth dollars [after-tax] when current tax rates are low) why has Congress adopted a regime that limits Roth availability to those with incomes above a certain amount? To ultimately increase tax revenues they should be discouraging those with lower current income and encouraging those with higher current income.

It has been my experience that people in lower tax brackets have virtually no interest in Roth.

[Peter Gulia]

Doesn't JRN's query suppose that the plan sponsor decides only which default (Roth or non-Roth) to apply for a participant who has not (yet) specified the participant's choice?

And if a plan's sponsor must specify one default or the other, is a reasonable guess about what a typical participant in an affected class would or should prefer a good-enough provision?

[RatherBeGolfing]

The ER shouldn't make this decision, period. I'm not going to get on my soap box in regards to auto- enrollment in general, but if you are going to do it, you need to treat everyone as equals. Income & tax rates are not the only factors when it comes to Roth, so it does not make ANY sense for the ER to make this decision for the EE.

[BG5150]

How would it work on the record keeping system? How will it know who is slated to make more than $45k? Is it an annualized figure? What if I'm supposed to make $60 this year, enter the plan on July 1, but I get fired in September after making only $40k?

What happens from year-to-year, if people go above and below the waterline? I make $42k this year and I'm in Roth at 3%. Next year I make $46k and I'm now 4% in pre-tax? Or does it all stem from my initial auto enroll type?

[austin3515]

I get this design, I don't think it's whack at all. Complicated, off the beaten path, yes indeed. But I certainly appreciate the desired outcome.

Try this though. Default everyone to Roth. The lower paid people are less likely to make an election (at least that's my assumption) so the default should be what is best for them,. The higher paid people will fill out a form electing pre-tax if they want to.

That's the position I took anyway when I default enrolled a plan in Roth. Their rank and file people are young and low paid. So Roth defaulting was a home-run.

[Tom Poje]

I'm not even sure (unless it is individually designed) if most documents would have such an option available.

[GMK]

If you have automatic enrollment, it's the Plan Administrator's responsibility to designate the default deferral rate and the default investment election for those who do not make those elections themselves. You 'splain to the newly-eligible persons clearly and precisely what happens if they do not make the elections themselves.

The PA's choices of deferral rate and default investment are fiduciary functions, the same as if the PA designated target-date funds or a balanced fund or whatever as the default. The assumptions on which the choices are based may not fit everybody's circumstances, but that's OK if the defaults provide a reasonable starting point for participation in the Plan.

[Peter Gulia]

Answers to Tom Poje’s questions relate to GMK’s observations.

In 2014, I reviewed a “micro” client’s use of IRS-preapproved documents sponsored by a “mega” national bank. That form included a few pages of Adoption Agreement choices to specify several details for an automatic-contribution arrangement. These included a check-off box to specify that automatic elective deferrals are Roth contributions. (The form has a copyright notice that refers to the bank “or its suppliers”; I believe the form is the work of one of the big plan-document publishers.)

To the extent that an automatic-contribution arrangement’s defaults are specified in the plan, ordinarily the plan’s administrator need not make a discretionary choice, and ordinarily should administer the plan “in accordance with the documents and instruments governing the plan[.]” ERISA § 401(a)(1)(D). A plan’s administrator might have some duty to go beyond the plan’s provisions if a provision is inconsistent with ERISA’s title I or title IV.

GMK is right that even a fiduciary choice need not perfectly fit each individual. Rather, it can be prudent for a fiduciary to consider all of the surrounding facts and circumstances, including practical constraints, and impartial balancing of different and differing needs, interests, and preferences, to decide a choice for a wide class.

[RatherBeGolfing]

GMK is right that even a fiduciary choice need not perfectly fit each individual. Rather, it can be prudent for a fiduciary to consider all of the surrounding facts and circumstances (emphasis added), including practical constraints, and impartial balancing of different and differing needs, interests, and preferences, to decide a choice for a wide class.

I see your point, but in this case it is simply impossible for the PA to know all surrounding facts and circumstances. For that reason alone, I would never advise a PA to make this type of call on behalf of the participants. I just don't see how making this type of decision based on some partial facts known to the PA can be prudent.

[austin3515]

If a plan offers Roth and Pre-Tax aren't you making similar presumptions when you choose one over the other? Taking into account ONE determinative variables as opposed to NONE can only ensure that more people end up in the right place. And because I just don't see a nondiscrimination issue with the assumption I can't imagine why it wouldn't be allowed, subject only to any restrictions in the pre-approved plans.

[MoJo]

Being "allowed" and being "prudent" are two different things. I have no problem with the FIDUCIARY decision being made by a plan fiduciary (just as having a plan fiduciary making all investment decisions and not allowing participant direction is "allowed.") The question still remains as to WHY a fiduciary would want to make that decision? The way I look at it is, if you take into consideration ONE fact or factor, explain to me why you chose THAT particular fact or factor in making your decision, but chose NOT to take into consideration x, y & z facts or factors in making that decision? It's the distinguishing between two groups on the basis of ONE factor that causes me concern - and will be the crux of the fiduciary's defense when sued. Now one could argue that TDF's do the same thing - BUT 1) the industry has recognized that as "more" prudent than virtually all other investment options; 2) the options glide path ensure that the investments change when the one factor considered changes; and 3) there is safety in numbers - prudence is determined by what OTHER experts would do, and many, many other experts use TDF's. I am aware of none that actually make a "tax" decision for employees.

[austin3515]

The way I look at it is, if you take into consideration ONE fact or factor, explain to me why you chose THAT particular fact or factor in making your decision, but chose NOT to take into consideration x, y & z facts or factors in making that decision? I

I have a great answer. Because it is a key factor, and it is objective and readily determinable by the plan administrator. Heck I'd say throw age in their too except then you get really really complicated.

[austin3515]

The question still remains as to WHY a fiduciary would want to make that decision?

Again, my position is that the fiduciary IS choosing anyway, because they are choosing between Roth and Pre-Tax. You're assuming that if they "just use pre-tax" that they did not make a choice, but they did.

[MoJo]

Yes, a fiduciary is making a decision when they select defaults for an auto enrollment program, BUT 1) they have legislation that provides guidance and safe harbors; 2) they have regulations that define a QDIA for purposes of a safe harbor for THAT decisions; and 3) they have the BODY OF EXPERIENCE of other PRUDENT EXPERTS who have done it - therefore fulfilling the "what other experts do" part of prudence. I have NEVER seen one make a determination that "you" go Roth and "you" go pre-tax, nor do I see ANY evidence that the one factor they have selected is indeed a KEY factor. Experts have been debating Roth and the decision making process for as long as Roth has been available, and I see NO consistency in approach.

Not what "other" prudent experts would do....

[Tom Poje]

but in all the discussions on the plusses or minuses of Roth I haven't seen the following, and maybe I don't understand the rules properly, or maybe the effect would be minimal.

if you are receiving Soc Sec, you will be taxed if your adjusted gross income is above 25,000 (for a single person, 32,000 joint filing) and I believe Pension income counts toward that 25,000, but I don't believe Roth would as that has already been taxed.

[Peter Gulia]

Without entering or remarking on this debate about how a fiduciary might go about its decision-making (if any), consider the likelihood that the plan’s governing documents will specify this provision.

If the plan sponsor uses a set of IRS-preapproved documents and that form affords a choice to provide automatic elective deferrals as Roth or non-Roth contributions, the plan sponsor will have made the choice. If the document sponsor’s form permits a user to provide an automatic-contribution arrangement but doesn’t allow a choice between making the automatic elective deferrals Roth or non-Roth, the plan sponsor’s act of adopting the documents adopts whichever provision is set by the document sponsor’s documents.

And if the plan sponsor uses an individually-designed document, the plan document may specify whether automatic elective deferrals are Roth or non-Roth.

If the plan sponsor specifies this Roth or non-Roth provision for automatic elective deferrals in the plan’s governing documents, there ordinarily is no need for a fiduciary’s choice. Rather, the plan’s administrator obeys a plan document.

A single-employer plan sponsor’s act of adopting or changing a retirement plan need not be constrained by ERISA fiduciary duties and, absent a collective-bargaining duty or obligation, might involve decisions the plan sponsor alone may consider as a business organization.

Under ERISA’s settlor doctrine, a plan sponsor can have made a plan provision that results in an unwise choice for a particular participant (or even many of them), and yet bears no ERISA fiduciary responsibility for such a plan-design choice.

{This academic conversation among practitioners is not legal advice to anyone.}

[TPAJake]

We can discuss legality all day, but the reality is that auto enrollment is complicated enough for Sponsors. No way I'd have 2 sets of criteria--I say pick one & let them make their elections.