401(k) Enrollment Whether You Ask for It or Not

Earlier this year, Hewlett-Packard Co. discovered a problem with its 401(k) retirement plan: Less than half the company’s new hires were taking immediate advantage of it. That was a far cry from the 84% participation rate of more experienced workers.

So it tried something different.

The Palo Alto-based computer maker, like a tiny but growing number of companies nationwide, began to automatically enroll them.

In other words, instead of waiting for new hires to fill out and hand in 401(k) enrollment forms, the company in February began automatically withholding 3% of their wages and directing that money to a money market fund within company-sponsored, tax-deferred 401(k)s in their name.

Workers who want to participate don’t need to do a thing. Only those new hires who choose not to participate--or those who want to change the amount directed or the investment option--need to notify the company.

“A lot of times, employees forget to turn the forms in or they procrastinate,” said Vicki Dotterer, HP’s in-house retirement consultant. And some don’t fully grasp how important it is to contribute--and contribute early--to a tax-deferred 401(k).

The result? HP reports that 98% of new employees now take immediate advantage of their 401(k)s.

So the question is, why haven’t more California companies embraced such a system? After all, the IRS has cleared it, and President Clinton has endorsed it as a good way to boost 401(k) participation.

One big reason is that companies aren’t entirely convinced such a system, depending on how it’s structured, is legal considering state law.

“It’s an open question,” said David West, an employee benefits attorney with Gibson, Dunn & Crutcher in Los Angeles.

The problem is this: According to California Labor Code Section 224, employers are not authorized “to withhold or divert any portion of an employee’s wages,” unless they are required to do so by state or federal law or unless a deduction is “expressly authorized in writing” by the employee.

Because automatic enrollment does not require workers to turn in an enrollment form, it is unclear if companies can legally divert wages to a 401(k) this way.

“It may be legal under IRS rules and regulations and under federal labor laws,” state Labor Commissioner Jose Millan said. But if companies don’t get some form of written authorization, “it is in violation of Section 224.”

But do state laws even apply?

Hewlett-Packard and many labor attorneys argue that federal pension laws--particularly the Employee Retirement Income Security Act (ERISA) of 1974--preempt state law.

But Millan says federal laws apply after the money is deposited into retirement funds, not to the withholding process.

This issue “is about as clear as mud,” said Tom Kirschbaum, an employee benefits attorney with the law firm Irell & Manella in Century City. Kirschbaum is advising his clients who are thinking of switching to an automatic enrollment system to “wait until the law becomes clearer.”

Millan said his office was not aware that any company in the state had moved to automatic enrollment. If he finds some that have, he said, he will write to them seeking clarification as to how they are complying with Section 224.

He added that something as simple as a confirmation note, signed and returned by employees stating that they understand how the system works and either agree to it or not may suffice.

Kaynar Technologies Inc. requires such a form. The Orange-based manufacturer of aircraft and defense components, which switched to automatic enrollment about three months ago, asks new hires to sign a form stating that they understand how the system works and that they agree to it or don’t. It also gives them a chance to increase or decrease contributions to their plans before they are swept into the 401(k).

Irvine-based Allergan Inc., which manufactures eye-care and skin-care products, will require something similar when it moves to automatic enrollment Jan. 1.

But Robin Radin of Ernst & Young’s personal financial counseling practice in Los Angeles, commented, “How automatic is automatic if you have to sign and return a sheet?”

Indeed, if companies in California and other states with similar laws are required to get employees to sign forms even under automatic enrollment, won’t that defeat the purpose of automatic enrollment, which is to boost participation rates by getting rid of paperwork?

Newly elected Assemblyman Darrell Steinberg (D-Sacramento), new chairman of the Assembly Labor and Employment Committee, said he will look into this problem when the Legislature reconvenes in January.

“There should be a reasonable solution,” he said. “The underlying policy is a good one. We ought to be encouraging people to save and invest.”

Nationwide, 7% of 401(k) plan sponsors--a list that includes Motorola Inc., McDonald’s Corp. and Freddie Mac--now offer automatic enrollment of some kind, and 28% say they will consider it, according to a recent survey by New York-based Buck Consultants.

The move is designed to boost participation rates at a time when 401(k) plans are expected to play an increasingly important role in workers’ retirement savings.

Automatic enrollment, often referred to as “negative election,” is seen as an especially useful tool to increase retirement plan participation among younger, less experienced and unskilled workers.

At McDonald’s, for instance, a company with a large number of unskilled workers, participation rates are at 95% and have hovered there for the dozen years the system has been in place, a spokeswoman for the fast-food chain said. That compares with a national average of about 70%.

“It sounds like a small thing, but it’s one thing that can really affect a very large number of people in getting them into the business of saving for their own retirement,” President Clinton said at the National Summit for Retirement Savings in June.

Eddie Chavoya, who works as a tool crib attendant at Kaynar’s Fullerton plant, agrees. The 29-year-old Anaheim resident was automatically placed in his company’s 401(k) when he started in September. “It just makes things a lot easier,” he said, noting that complicated enrollment forms can often be intimidating to workers who aren’t familiar with how a 401(k) works.

“If I’m an employee and I don’t fully understand the benefit of saving in a 401(k), and all of a sudden money is being taken out of my paycheck, and all of a sudden I realize it doesn’t hurt that much once it’s netted out, and now I get a benefit statement showing how much my money is growing, I’m going to want to continue participating,” said Thomas Foster, ERISA counsel for John Hancock Retirement Services.

Increased participation not only benefits the individual employees, it benefits companies too. This is because all 401(k) plans must submit to a set of annual discrimination tests to ensure that highly paid workers aren’t benefiting disproportionately from the plan. The more that non-highly paid workers--those making less than $80,000--contribute to their plans, the more highly paid workers can contribute to theirs.

This helps companies retain and recruit managers and other skilled labor, employee benefits consultants say.

Of course, not everyone believes automatic enrollment is the best way to boost participation.

“Companies are better off trying to buttonhole people and educate them,” said Kirschbaum of Irell & Manella. For instance, he fears that under automatic enrollment, some employees might not realize that money is being deducted into a 401(k) for them. And once they find out, it may be too late to get that money back if they want it--since employees usually can’t withdraw money from a 401(k) until they turn 59 1/2 without paying taxes and a hefty penalty.

Ernst & Young’s Radin agrees.

“Ernst & Young’s view is that automatic enrollment should be a last or one of the final resorts for companies that just can’t get their participation numbers up,” she said.

For starters, there’s an extra educational burden on companies that switch to automatic enrollment.

Also, companies must decide how much money to automatically withdraw and which investment option to use as a default.

The need for automatic enrollment plans also raises this question: If employees don’t know enough about the value of 401(k)s to turn in an enrollment form, what does this say about their ability to manage their savings?

“Automatic is a very paternalistic method of getting people into these plans,” Radin said, noting that this goes against the growing trend in employee benefits to put individuals in charge.

If this is the case, “one can argue that you might as well go back to [traditional] defined-benefit [pension] plans.”

Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.