AUTOMATIC ENROLLMENT
March 5, 2008
Scott Thole, HORAN
 
Automatic enrollment or negative election for 401(k) plans has been in existence for many years. However, until the Pension Protection Act (PPA) was passed in 2006, these types of plans were rarely used. The new law offers protection to plan sponsors from a fiduciary standpoint, which has allowed a growing number of plan sponsors to add automatic enrollment to their plans. This new legislation allows companies to avoid current state laws that prohibit paycheck deductions without employee permission.
 
There are two main reasons plan sponsors are adopting automatic enrollment:
Employer was to raise 401(k) participation levels.  Employees not participating in a 401(k) plan, tend to continue not to participate. Companies can help employees overcome this inertia by automatically enrolling them in the plan.
The Plan is failing its annual nondiscrimination testing.  By adding an automatic enrollment feature to the plan, the testing results are often significantly improved because more non-highly compensated employees participate in the plan.
 
What Types of Automatic Enrollments Does the New Law Allow?  There are two types of automatic contribution arrangements under the PPA: Eligible Automatic Contribution Arrangements (EACA) and Qualified Automatic Contribution Arrangements (QACA).
 
Eligible Automatic Contribution Arrangements (EACA)  If employers apply a uniform automatic contribution percentage for all employees, invest the contributions in a Qualified Default Investment Alternative, and provide the required notices to employees, the employer can then:
  • Take up to six months after the end of the plan year to perform nondiscrimination test and make corrections.
  • Employers may refund 401(k) deferrals for those employees who do not want to participate and failed to opt out, within 90 days after automatic enrollment begins.

Qualified Automatic  Contribution Arrangements (QACA)  PPA waives the nondiscrimination testing requirement for plan sponsors who have a Qualified Automatic Contribution Arrangement. These are known as safe harbor automatic enrollment arrangements. This requires meeting the EACA requirements above and also doing the following:

  • The initial automatic enrollment amount must be at least 3% (but not more than 10%) of pay and you must annually increase this amount by 1-2% each year to a minimum of 6%.
  • The employer must fund a "safe harbor" contribution which must be 100% vested after two years of service. The minimum employer safe harbor contribution options are: 1) Matching contributions: 100% of first 1% deferred + 50% of next 5% deferred for a maximum of 3.5% of pay match or 2) Non-elective contributions: 3% of pay for all eligible employees, whether or not they are contributing to the plan. The QACA provisions must be in place before the beginning of the plan year and must stay in place for the entire plan year. There are also annual employee notice requirements.

Automatic Contribution Increases  To eliminate nondiscrimination testing, employers must adhere to a minimum set of automatic employee contribution levels and annual contribution increase amounts. Plan sponsors who do not want to administer annual automatic increases can institute an initial automatic enrollment level of 6%.

How Is the Money Invested?  Employers must also decide how to invest automatic enrollment contributions since the employee is not making this election. The Pension Protection Act now offers fiduciary protection if you invest the money in a Qualified Default Investment Alternative.
 
Qualified Default Investment Alternative (QDIA)  To have fiduciary protection fro investment of automatic contributions, employers must invest the automatic enrollment contributions in a QDIA. With QDIA's, when the participant is automatically enrolled and have their money automatically invested in the QDIA, the plan sponsor is protected from liability. The Department of Labor recently issued final regulations defining which investments qualify as QDIA's:
  • A product with a mix of investments that takes into account the individual's age, target retirement date or life expectancy (for example, a life-cycle or targeted-retirement-date fund).
  • A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (for example, a balanced fund).
  • An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual's age, target retirement date or life expectancy (for example, a professionally managed account).
  • A product designed to preserve principal and provide a reasonable rate of return consistent with liquidity. This type of investment product will only be considered a QDIA for no more than 120 days after the date of the particpant's first account (for example a money market fund).
  • A product or fund designed to guarantee principal and a rate of return generally consistent with that earned on intermediate investment grade bonds, and provides liquidity with no fees or surrender charges at the time of withdrawal. These will be considered a QDIA for assets invested in them prior to December 24, 2007, but will not be QDIA's after that (for example, a stable value fund).

Annual QDIA Notices  To meet the QDIA rules, the plan sponsor must provide notice to employees describing the QDIA. It must be given at least 30 days in advance of the first investment and annually thereafter. It must include an easy to understand explanation of:

  • Why, when and where money will be invested.
  • Fund objectives, risk and return information, and disclosure of fees and expenses.
  • Information on how to transfer money to other investments within the plan.
  • Instructions on where to obtain other plan investment information.

Although Pension Protection Act 2006 legislation has been passed, the IRS has not published their final guidance on automatic enrollments. These new rules are applicable for plan years beginning on or after December 21, 2007 so final guidance is expected soon.

This article is intended to be educational in nature and does not constitute legal advice.
 
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