Proposed Regulations Released on Automatic EnrollmentBrian Pinheiro, Virginia E. Neiswender and Samantha E. M
March 19, 2008 — 1,465 views
On the heels of the Department of Labor’s qualified default investment alternative regulations, the Department of the Treasury released last week proposed regulations on automatic contribution arrangements, providing long-awaited guidance for plan sponsors and fiduciaries. The Pension Protection Act of 2006 codified the Internal Revenue Service’s prior approval of “automatic enrollment” 401(k) plans, section 457 state and local government plans and section 403(b) tax-sheltered annuities, and added a second safe harbor plan design for 401(k) plans that allows plan sponsors to avoid certain nondiscrimination testing. In addition, the PPA added a limited means by which participants may withdraw automatic contributions without penalty. The proposed regulations are effective for plan years beginning on or after January 1, 2008, and may be relied upon pending the publication of final rules.
Comment. As plan sponsors struggle with ways to encourage their employees to increase their savings toward retirement, the qualified automatic contribution arrangement, described below, creates an opportunity for plan sponsors to increase employee savings while also avoiding nondiscrimination testing. For plan sponsors with an existing 401(k) plan who choose to adopt a QACA, the plan sponsor must amend the plan prior to the beginning of the plan year and must provide the required advance notice under the regulations. To maximize relief for fiduciaries of defined contribution plans that include a QACA or other automatic enrollment feature with a QDIA, notices must be provided to participants and eligible employees no later than November 30, 2007. (See the Employee Benefits and Executive Compensation Group’s e-Alert dated October 31, 2007 regarding QDIAs.)
Lawyers in our Employee Benefits and Executive Compensation Group are ready to assist you in preparing the necessary plan amendments and required notices, and otherwise complying with the new requirements.
Qualified Automatic Contribution Arrangements
Section 902 of the PPA added an additional safe harbor plan design for 401(k) plans that allows such plans to avoid certain nondiscrimination testing and the top-heavy rules if the plan qualifies as a QACA. The plan sponsor must amend the plan to include the QACA before the first day of a plan year and the QACA must remain in effect for an entire 12-month plan year. A plan is a QACA if:
- New employees and employees who have not affirmatively declined to defer compensation under the plan are automatically enrolled;
- The automatic contribution is no less than 3 percent of compensation in the first year, increasing by at least 1 percent per year up to 6 percent of compensation in the fourth year, but not exceeding 10 percent of compensation in any plan year;
- The plan sponsor makes either a matching contribution of 100 percent of the first 1 percent of compensation and 50 percent of up to the next 5 percent of compensation (for a maximum match of 3.5 percent of compensation), or a nonelective contribution equal to 3 percent of compensation;
- Participants are 100 percent vested in employer contributions after completing no more than two years of service; and
- Participants and eligible employees receive the required annual notice.
The required employee contribution under a QACA must apply uniformly to all eligible employees unless (1) the variation is based on the number of years an eligible employee has participated in a QACA; (2) the participant’s affirmative election that was made prior to the adoption of the QACA remains in effect; (3) the applicable limits of the Internal Revenue Code would be exceeded; or (4) a six month suspension period following a hardship distribution is in effect and contributions automatically resume at the end of the period.
Comment. Plan sponsors are not required, but may elect, to include those eligible employees who, prior to the effective date of the QACA, have an affirmative deferral election on file with the plan sponsor. However, plan sponsors must apply the QACA contribution percentage to all existing and newly hired eligible employees who have not made an affirmative deferral election.
The initial QACA contribution must remain in effect for the plan year in which the eligible employee is first enrolled through the end of the following plan year. This means that the initial QACA contribution could be in effect for two full plan years.
If a plan sponsor wants to take advantage of this safe harbor and avoid nondiscrimination testing for the 2008 plan year, the plan must be amended prior to December 31, 2007. In addition, the plan sponsor must provide the requisite notice by November 30, 2007, as more fully described below.
Eligible Automatic Contribution Arrangements
The PPA permits plans to allow participants to withdraw automatic deferrals without being subject to the 10 percent early withdrawal tax, provided that the plan is designed as an eligible automatic contribution arrangement. A plan provides for an EACA if:
- The plan is a 401(k), 403(b) or 457(b) arrangement;
- The participant is automatically enrolled at a default percentage unless the participant affirmatively elects otherwise;
- Absent an affirmative investment election by the participant, such contributions are invested in a default investment (this requirement does not apply to governmental and church plans not subject to Title I of ERISA); and
- Participants are provided an EACA notice (described below).
A plan featuring an EACA may permit a participant to request a withdrawal of amounts automatically contributed, provided that the participant requests the withdrawal within 90 days of his or her first automatic deferral. Returned amounts must be distributed with earnings, if any, and are treated as taxable income in the year they are withdrawn. Upon withdrawal of the automatic deferrals, the employee forfeits all associated employer matching contributions. All forfeited amounts must remain in the plan. An employer cannot preclude an employee from making future elective contributions to the plan simply because the employee opted to take a permissible withdrawal within the first 90 days of participation.
Comment. The permissible withdrawal of automatic deferrals is not required in either a QACA or an automatic enrollment plan. However, if permissible withdrawals are allowed, plans must not charge an additional fee if a participant requests such a withdrawal.
Plan sponsors satisfy the QACA notice requirements by providing a notice to participants at least 30 days (and no more than 90 days) before the beginning of each plan year. If an employee does not receive a notice prior to the plan year, the notice must be provided no more than 90 days before the employee becomes eligible and no later than the date of eligibility. This notice must provide:
- The level of automatic deferrals that will be made to the plan on the employee’s behalf;
- An explanation of the employee’s right under the QACA to affirmatively elect not to have contributions made on the employee’s behalf or to change the contribution percentage; and
- Information regarding how contributions made under the automatic contribution arrangement will be invested in the absence of any affirmative investment decision by the employee.
Comment. Similar to the requirements for the QDIA notice, the notice must be provided separately, and not as part of a summary plan description. For those plan sponsors who decide to implement a QACA for the 2008 plan year, notices must be sent to participants by November 30, 2007. The IRS has announced that it will provide a sample QACA notice on its website shortly. The notice requirements above are similar for EACAs but must also describe an employee’s right to withdraw any automatic contributions and the procedures to do so.
The required notices for QACAs and EACAs can also be coordinated with the QDIA notice to provide the maximum protection for fiduciaries while providing participants with complete and accurate information. This combined notice must include, in part, information regarding the default deferral percentage under the plan, the default investment options, how to opt out of the automatic deferral and the procedures for permissible withdrawals, if applicable, and must be provided within the prescribed time frame.
Corrective Distributions of Excess Contributions
The proposed regulations also reflect the PPA amendments which permit a plan featuring an EACA to distribute excess contributions and excess aggregate contributions up to six months after the close of the plan year without subjecting the plan sponsor to a 10 percent excise tax. NonEACA plans continue to have only 2½ months following the plan year to distribute excess amounts without penalty.
Comment. The extended period for distributing excess amounts applies to distributions for excess contributions and excess aggregate contributions for the 2008 plan year.
Brian Pinheiro, Virginia E. Neiswender and Samantha E. M
Ballard Spahr Andrews & Ingersoll, LLP