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This Employer Webinar Series program is presented by Spencer Fane Britt & Browne LLP in conjunction with United Benefit Advisors. Automatic Enrollment in 401(k) Plans. Presented by: Rob Browning and Ken Mason. Meet The Presenters. Kenneth Mason Spencer Fane Britt & Browne LLP

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Automatic enrollment in 401 k plans

This Employer Webinar Series program is presented by Spencer Fane Britt & Browne LLPin conjunction with United Benefit Advisors

Automatic enrollment in 401 k plans

Automatic Enrollment in 401(k) Plans

Presented by:

Rob Browning and

Ken Mason

Meet the presenters
Meet The Presenters

Kenneth Mason

Spencer Fane Britt & Browne LLP


Ken Mason

Robert Browning

Spencer Fane Britt & Browne LLP


Topics of discussion
Topics of Discussion

  • Automatic Enrollment before PPA of 2006

  • Pension Protection Act codification of automatic enrollment/preemption of state law and creation of new safe harbor

  • IRS and DOL Regulations regarding automatic enrollment, default investment options

  • Recent statutory tweaks – WRERA

  • Recent IRS guidance, model language

  • Correction of auto-enrollment errors

Automatic enrollment before 2007
Automatic Enrollment before 2007

  • Originally called “negative election”

  • McDonalds may have had first plan

  • Early IRS guidance:

    • Rev. Rul. 98-30 – 401(k) (new employees)

    • Rev. Rul. 2000-8 - 401(k) (current employees)

    • Rev. Rul. 2000-33 – 457(b) plans

    • Rev. Rul. 2000-35 – 403(b) plans

    • Ann. 2000 – available option for prototype plans

  • Final 401(k) regulations (issued in 2004, effective in 2006) define “cash or deferred arrangement” to include deferral by default

Issues concerns before ppa
Issues/Concerns before PPA

  • New vs. Current Employees

  • State Laws re: withholding from wages

    • Laws vary from state to state

    • ERISA Preemption – DOL view:

      • Advisory Opinion 94-27A

      • Advisory Opinion 96-01A

  • Fiduciary Liability for “default” investments

    • No ERISA Section 404(c) protection

  • Status as “elective deferrals” subject to 402(g) limit ($16,500 in 2009)

  • Negative election vs mandatory contribution

Pension protection act of 2006
Pension Protection Act of 2006

  • 404(c) fiduciary relief for “qualified default investment alternatives”

  • Preemption of state laws that restrict “automatic contribution arrangements”

  • 90-day withdrawal feature for “eligible automatic contribution arrangements”

  • Nondiscrimination safe harbor for “qualified automatic contribution arrangements”

  • Acronyms: QDIA, ACA, EACA, QACA

Default investments
Default Investments

  • Prior to PPA, no ERISA 404(c) protection for amounts invested by “default”

  • PPA adds ERISA Section 404(c)(5):

    • Participant in individual account plan is treated as exercising control over the assets in his/her account (including automatic contributions) if amounts are invested in accordance with DOL regulations re: QDIAs

    • Requires notice prior to each plan year

  • Effective for plan years after 12/31/06

  • DOL was required to issue regulations within six months after August 17, 2006

  • Final QDIA regulations issued October 24, 2007 (generally effective Dec. 24, 2007)

Preemption of state law
Preemption of State Law

  • PPA adds ERISA Section 514:

    • ERISA supersedes any state law which would prohibit or restrict a plan from including an “automatic contribution arrangement” (ACA)

  • ACA – an arrangement where:

    • Participant may elect cash or deferral

    • If no election, participant is treated as electing to defer a uniform % of compensation

    • Participant may elect a lower % (or no deferral) at any time

    • Contributions are invested in a QDIA

Preemption of state law1
Preemption of State Law

  • Statute requires notice to participants prior to beginning of plan year

  • Substantial penalty for failure to provide the required ACA notice – DOL may assess a civil penalty of up to $1,000 per day for each violation

  • Effective date of preemption provision was August 17, 2006

Preemption of state law scope
Preemption of State Law - Scope

  • DOL authorized to issue regulations regarding minimum standards for arrangements entitled to preemption

  • Legislative history: state preemption rules are not limited to arrangements that are “ACAs” under ERISA

  • Final regulations re: QDIAs confirm:

    • Preemption not limited to arrangements meeting ERISA definition of ACA

    • Pension plans may have an ACA that does not use QDIAs

90 day withdrawals under eacas
90-day Withdrawals under EACAs

  • Code Section 414(w) – allows withdrawal of automatic contributions under an EACA (does not violate distribution restrictions)

  • Must elect to withdraw within 90 days after the first “automatic” contribution

  • Must withdraw automatic contributions and earnings through date of election

  • Distributions are taxable in year of distribution

  • No 10% penalty tax on distribution

Eaca defined
EACA Defined

  • An EACA is an arrangement where:

    • Participant may elect cash or deferral

    • If no election, participant is treated as electing to defer uniform % of pay until the participant elects otherwise

    • Advance notice requirement is satisfied

    • Contributions are invested in a QDIA*

  • * = QDIA requirement was removed by WRERA 2008

Eacas additional rules
EACAs – additional rules

  • Applies to 401(a), 403(b), govtl 457(b) plans

  • Employer has six months (rather than 2 ½ months) to distribute excess contributions (ADP failures) and excess aggregate contributions (ACP failures) before distribution will be subject to 10% excise tax

  • Distributions of ADP/ACP excesses are no longer required to include “gap period” income

Nondiscrimination safe harbor
Nondiscrimination Safe Harbor

  • New Code Sections create additional “safe harbor” from ADP/ACP testing for QACAs (for plan years beginning in 2008 or later)

  • QACA – an arrangement with:

    • Specific auto-enrollment requirements

    • Automatic increase requirements

    • Required employer contributions

    • Two-year cliff vesting of ER contributions

  • Applies to 401(k), 403(b), govtl 457(b) plans

Qacas automatic contributions
QACAs – Automatic Contributions

  • Automatic contribution percentage cannot exceed 10% of compensation

  • Contribution percentage for participant’s first two years of participation in the QACA must be at least 3% of compensation

  • Contribution percentage must be at least 4% in third year, 5% in fourth year, and 6% in any later year

Qacas employer contributions
QACAs – Employer Contributions

  • Matching contributions option:

    • 100% of first 1% of pay deferred; plus

    • 50% of next 5% of pay deferred

    • (3.5% employer contribution for those who defer at least 6% of pay)

  • Nonelective contributions option:

    • 3% of compensation for all employees

  • Employer contributions must be 100% vested after 2 years of service

Qacas other requirements
QACAs – other requirements

  • Employer contributions are subject to the same withdrawal restrictions as elective deferrals (i.e., like QNECs)

  • Each employee eligible to participate in the QACA for the upcoming year must receive written notice before the beginning of the plan year

  • QACAs - exempt from top-heavy rules

Guidance since ppa
Guidance Since PPA

  • Proposed regulations (2007) answered certain questions raised by PPA, but imposed many restrictions

  • WRERA (2008) eased a few requirements (e.g., EACA need not use QDIA as default investment)

  • Final regulations (March 2009) eased other requirements (especially regarding timing of notices and “limited EACAs”)

Guidance since ppa1
Guidance Since PPA

  • IRS Retirement Plans Newsletters (Summer and Fall 2009) provided correction guidance

  • Obama Administration’s Labor Day Weekend guidance:

    • Clarified rules for auto deferral increases (Rev. Rul. 2009-30)

    • Provided model plan language for ACAs and EACAs (Notice 2009-65)

Auto enrollment advantages
Auto Enrollment Advantages

  • Encourages employees to save for their retirement (inertia principle)

  • Facilitates larger deferrals by highly compensated employees (HCEs)

    • More deferrals by non-HCEs improves ADP/ACP test results

    • QACA allows HCEs to defer maximum dollar limit for year

Current trends
Current Trends

  • Recent Watson Wyatt survey found that 47% of large employers use auto enrollment, with another 1/3 of remaining employers considering doing so

  • 51% of current auto deferral arrangements include auto increase feature

  • Median initial auto deferral percentage = 3% (range = 1% to 7%)

  • Median final auto deferral percentage = 6% (range = 3% to 20%)

Qaca advantages
QACA Advantages

  • No ADP/ACP testing or correction required

  • Exempt from top-heavy rules

  • May apply (limited) vesting schedule to safe-harbor employer contributions

Qaca requirements
QACA Requirements

  • Must include all eligible employees who have not made prior deferral election (including election not to defer)

  • Initial auto deferral percentage must be at least 3%

    • Auto deferral percentages must be “uniform,” and

    • Must provide for automatic increases in auto deferrals

  • Minimum employer safe-harbor contribution

  • Notice of QACA must be provided during reasonable period before each plan year and before employee becomes eligible

  • Must be in effect for full plan year

Auto increase rules
Auto Increase Rules

  • Employee’s auto deferral percentage must be at least 4% by first day of second plan year after first auto deferral is made

  • Auto deferral percentage must then increase by 1% on first day of each subsequent plan year, until at least 6% (capped at 10%)

  • Auto deferral percentage may start at more than 3%, so long as minimum schedule is met

  • Auto increases may take effect prior to first day of plan year, so long as minimum schedule is met. E.g.:

    • Each employee’s anniversary date, or

    • Uniform date for salary increases

Effects of breaks in service
Effects of Breaks in Service

  • General rule: Must disregard break in service when determining proper auto deferral percentage on rehire

    • Example: Employee whose default deferral percentage was 4% when terminating employment in October of 2010 -- and who fails to make affirmative deferral election upon reemployment in March of 2011 -- must have 5% default deferrals

  • Exception: Plan may treat employee with full plan-year break in employment as new employee

    • Example: If employee in above example had returned to employment in March of 2012, default deferrals could have been set at 3%

Safe harbor employer contributions
Safe-Harbor Employer Contributions

  • Permissible contribution formulas:

    • 3% nonelective contribution on behalf of all eligible employees, or

    • 100% match on first 1% of compensation deferred, plus 50% match on next 5% – for a total matching contribution of 3½%

  • Either type of safe-harbor contribution must be fully vested within 2 years

  • Safe-Harbor contributions are subject to same in-service withdrawal restrictions as QNECs (so not available for financial hardship or before age 59½)

Eaca advantages
EACA Advantages

  • May offer 90-day refund option

  • May take six months after end of plan year to correct ADP/ACP violation and still avoid 10% excise tax

    • Otherwise, correction required within 2½ months after end of plan year

    • Not available to “limited EACA”

Eaca requirements
EACA Requirements

  • Must designate which employees are in EACA

    • “Limited EACA” need not include all eligible employees, but may not utilize six-month correction period

    • May still offer 90-day refund option, so might be suitable for only new employees (who would not suffer reduction in take-home pay)

    • Would also allow implementation of EACA during plan year (contrary to general rule)

  • Must specify uniform auto deferral percentage

    • Unlike QACA, need not be at least 3% of compensation and need not increase over time

    • However, if increases are specified, must be uniform for all employees (subject to same exceptions as under QACA)

Eaca default investment
EACA Default Investment

  • PPA required that EACA default investment be QDIA

  • This requirement repealed by WRERA, for plan years beginning after 2007

    • May still be prudent to specify QDIA, for purposes of fiduciary protection

    • Per Watson Wyatt survey, 90% of large plans use QDIA, rather than stable value or money market fund

Six month correction period
Six-Month Correction Period

  • Available only if all eligible employees are in EACA (i.e., not a limited EACA)

  • Still allows for correction via either refunds or QNECs

  • Timely correction avoids 10% excise tax on excess contributions

  • Plan may still avoid disqualification by correcting during second six months of following plan year

90 day refund option
90-Day Refund Option

  • Maximum period for employee to request refund must begin on date of withholding, not deposit into trust

  • Plan may specify deadline of less than 90 days, so long as employee has at least 30 days to request refund

  • Plan must refund all deferrals made through date of request, as adjusted for investment gains or losses

  • Plan may refund limited deferrals made after request, through earlier of 30 days or second pay date after request

90 day refund option1
90-Day Refund Option

  • Refund must be made on same schedule as regular distributions

  • Tax treatment of refunds:

    • Treated as additional taxable compensation in year of refund

    • So not subject to 10% penalty on early withdrawals from retirement plan

    • But still reported on Form 1099-R, rather than W-2

Other auto deferral arrangements
Other Auto Deferral Arrangements

  • Employer may not need QACA or EACA to achieve goal of better participation by NHCEs

  • Simple auto enrollment arrangement avoids many requirements and restrictions:

    • Need not include all eligible employees

    • Need not specify uniform deferral percentage, either initially or over time. For example:

      • Some groups might start at 1% deferral percentage, while others start at 5%

      • Subsequent increases might vary with levels of pay increases, rather than being uniform

    • Need not provide employer safe-harbor contributions

Other auto deferral arrangements1
Other Auto Deferral Arrangements

  • Must still provide notice before auto deferrals begin

  • Must still allow employees to make contrary election (including total opt-out)

  • Still enjoy ERISA preemption of state wage payment laws

Notification requirements
Notification Requirements

  • Per IRS regulations, notice provided between 30 and 90 days prior to start of plan year satisfies “reasonable period” requirement

  • Moreover, if not possible to provide notice before employee becomes eligible, may provide notice after eligibility, so long as:

    • Notice is provided before first pay date

    • Employee has at least a reasonable period of time to make a contrary election, and

    • If Employee takes no action, automatic deferrals begin by later of second pay date or 30 days after notice is provided

Failure to provide notice
Failure to Provide Notice

  • Failure to provide annual notice may or may not require corrective action

    • Depends on whether facts and circumstances show that employee was nonetheless aware of auto deferral procedures

    • Consider such things as oral notice, inclusion in SPD, and receipt of prior annual notices

Failure to auto enroll
Failure to Auto Enroll

  • Recent IRS newsletter clarifies amount of QNECs required on failure to implement automatic enrollment

    • If proper notice was given, QNECs should be based on auto enrollment percentage

    • If no notice was given, QNECs should be based on average deferral percentage of excluded employee’s group (either HCE or NHCE), which may be higher than auto deferral percentage

Contact information
Contact Information

Kenneth Mason

Spencer Fane Britt & Browne LLP


Ken Mason

Robert Browning

Spencer Fane Britt & Browne LLP


Automatic enrollment in 401 k plans

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