Passing Your ADP Test – Here’s What You Need To Know

Increasing employee deferral rates is an excellent way to get more benefit from your company’s 401(k). Not only do higher saving rates help your employees build their retirement nest egg, but they also make it much easier for your plan to pass non-discrimination testing.  

The problem? Getting employees to save more of their paychecks is no walk in the park. This is where automatic escalation comes in.

Automatic escalation – oftentimes paired with automatic enrollment – automatically increases employee deferral rates by set amounts over set intervals. For instance, it might increase employee savings rates by 1% each year.

In this post, we’ll discuss automatic escalation and few different ways you can increase both savings and participation rates in your plan.

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Two Ways to Boost Deferral Rates

1. Set a higher default deferral rate: **it turns out that many plan sponsors who auto-enroll choose 3% as the default deferral rate. That’s quite a low rate considering that most employees should eventually defer at least 10% of their salary to build a solid retirement nest egg. And Vanguard found no evidence that higher deferral rates scare employees out of plans once they are enrolled.
2. Implement automatic escalation in your plan: **you can implement auto-escalation to boost deferral rates by 1% each year. Since there are few restrictions on auto-escalation, your plan could have deferrals automatically increase by 1% each year up to a cap of 10%, 11%, or higher (a qualified automatic enrollment arrangement does call for a 10% cap on automatic escalation).

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Automatic Escalation & Enrollment – Helping Employees Retire with Confidence

When paired with a meaningful default deferral rate, automatic escalation can increase the odds of a more secure retirement for your employees. The auto enrollment feature gets employees in the plan early.

A reasonable default deferral rate, combined with auto escalation, means that tax free compounding can do its work on higher account balances. Even slightly higher early account balances can make a big difference over years of investing.

As an example, consider a participant who invests $6,000 at the end of every year for 40 years. If that investor earns a 6% return each year, the account balance at the end of Year 40 would be $928,572.

Now consider an investor under the same scenario who invested $3,000 for the first five years, and $6,000 thereafter. Despite only contributing $15,000 less over the 40 years, the second investor would accumulate $130,162 less, or a total of $798,590. The difference is in the compounding of those first five $6,000 contributions over many years.

The Employee Benefit Research Institute (EBRI) has done considerable research on retirement plan attributes. EBRI studies have shown that proper use of automatic features can dramatically increase account balances by retirement.

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Automatic Escalation & Enrollment – Keys to Passing Non-Discrimination Tests

Automatic escalation combined with auto enrollment can improve plan health by boosting participation and deferral rates. That can mean less chance of failing certain non-discrimination tests.

For example, auto enrollment typically means more enrolled employees, and therefore, more assets flowing into the plan from non-highly compensated workers. And since top-heavy rules are concerned with the relationship between plan assets of key employees and total plan assets, high participation reduces the odds of a plan being top-heavy.

Similarly, the Actual Deferral Percentage (ADP) test measures the relationship between the contribution rates of highly compensated employees to non-highly compensated employees. Since auto escalation boosts contributions of the NHCEs, the features improves the odds of a good ADP test result.  

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Want to Escalate Your 401(k)?

At ForUsAll we use smart plan design and innovative technology to makes it easy to offer automatic enrollment and automatic escalation. If you’ve been wondering how to build up momentum in your 401(k) plan and get more employees saving for retirement, chat with one of our retirement plan consultants.

If recent test results have you leaning toward offering a Safe Harbor plan, you should know that a Safe Harbor approach is not always necessary to pass non-discrimination tests. One alternative is a plan that is great at getting employees to join and save at high rates. That means a plan that is user friendly, low hassle, automated, and accessible by mobile device. Getting employees engaged not only helps you pass non-discrimination tests, but also gets your employees on the path to meaningful retirement savings.

Talk to us today to learn how to escalate your 401(k).

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