What Is an Opt-Out Plan?

An opt-out plan is an employer-sponsored retirement savings program that automatically enrolls all employees into its 401(k) or simple IRA.

Companies that use the opt-out provision enroll all eligible employees into a default allocation at a set contribution rate, usually starting at around 3% of gross wages. Employees can change their contribution levels or opt out of the plan altogether. They also may change the investments their money goes into if the company offers choices.

Understanding the Opt-Out Plan

Opt-out plans differ. Some let employees withdraw automatic contributions, including any earnings, within 90 days of their first automatic contribution. Others automatically increase the default contribution rate every year that an employee participates in the plan, up to a maximum of 10%.

As with other employee-sponsored plans, some offer matching contributions. For example, the employer may match dollar-for-dollar on the automatic contribution up to a certain percentage. A 3% employer match is the average among employers who choose to offer one.

Employers need to abide by certain rules when offering these types of plans. For example, all employees must be 100% vested after no more than two years of service. Employees need to be offered opportunities to change their investment choices periodically.

An opt-out plan must spell out all rules to employees, provide notifications and disclosures, and execute the plan uniformly among all those who are eligible. 

Pros and Cons of an Opt-Out Plan 

Many workers in the U.S. do not sock away nearly enough for retirement, and some save nothing. Knowing this, some companies enact opt-out plans in an effort to boost the number of employees who save.

Opt-out plans tend to raise participation rates. However, they generally start at employee contribution levels that are too low to meaningly help them in retirement. This is hurtful to employees who tend not to take any action on their own, as they continue to under-invest over the long term. Without a periodic reminder that a 3% contribution, for example, is just a starting point, many may not save enough over the long run. 

For this reason, some argue that opt-out plans tend to lower employees’ total retirement contributions. To counter this possibility, some employers raise the employee contribution rate by 1% each year, with 10% the usual maximum.

There are other ways employers can encourage retirement contributions. Raising the company match is one of them. This may boost participation, though it costs the company more.