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Compliance Corner
November 2014

The Current Issue: Can Automatic Enrollment Make a Comeback?

Automatic enrollment is a practice aimed at getting employees to participate in a 401(k) plan by default. There are two theoretical benefits to auto enrollment:  more employees begin to accumulate retirement savings and  auto enrollment can improve nondiscrimination test results, which would enable highly compensated employees to defer more income into the 401(k) plan. By so doing, this practice addresses two issues: inertia and uncertainty.

The government is offering several incentives for 401(k) plans that provide Automatic Enrollment, including eliminating concerns that formerly led many plan sponsors to shy away from auto enrollment.

By definition, Auto enrollment only happens when the employee fails to advise the Plan whether, and to what extent, he or she wishes to participate. Thus, for example, unless the employee specifically declines plan participation, or elects a specific salary deferral rate, the employee is automatically enrolled at a pre-determined deferral rate (e.g.  6% of pay.)  Automatically enrolled employees are free to stop the automatic participation at any time.

Auto Enrollment took off after the Pension Protection Act of 2006 ("PPA") swept away any state laws that would prevent or restrict an employer from deducting 401(k) contributions from an employee's paycheck without his or her consent.  In addition, there are two other PPA related incentives for employers to use auto enrollment.  The first PPA gift is a longer period of time to correct discrimination failures under the ADP/ACP tests, without penalty.   Instead of a 2.5 month period, eligible plans are allowed a six month correction period. After this correction period, a federal 10% penalty tax applies to the amount of the correction.  The second PPA gift is a sort of "buyers' remorse" provision that auto enrollment plans can adopt.  This allows any participant who finds they are automatically contributing to a 401(k) plan to "opt out" within 90 days,  and receive a full refund of invested assets plus investment results to either the participant or the employer.

There are four (4) types of auto enrollment arrangements: the non-statutory Automatic Contribution Arrangement ("ACA"), the statutory ACA under ERISA Section 514(e), the Eligible Automatic Contribution Arrangement under Internal Revenue Code Section 414(w), and the Qualified Automatic Contribution Arrangement ("QACA") under IRC Section 401(k)(13).  Of these four possibilities, probably the most versatile is the QACA, which was effective in 2008.

The "QACA" : A Possible Alternative to traditional Safe Harbor Plans

A QACA, as noted above, is an automatic enrollment arrangement that has a safe harbor provision so that no discrimination testing is needed. This looks a lot like the traditional safe harbor plans that 401(k) plans that plan sponsors have been using for years, but with a number of important attributes.  First, the employer contributions do not need to become 100% vested until after two years of service.  That permits forfeitures for employees who leave with under two years.  Second, if the employer chooses to make contributions on a matching basis, the maximum contribution is 3.5% of pay instead of 4% required of most safe harbor plans.  The QACA matching formula is 100% of deferrals up to 1% of pay plus 50% of deferrals between 1% and 6% of pay. Alternatively, the plan sponsor may make a 3% non-elective contribution to all eligible participants.  Third, it must have an automatic escalator provision that automatically boosts the deferral rate from a minimum of 3% of pay in the first year to a minimum 6% by the fourth year of participation. This has proven to be quite attractive to 401(k) plan sponsors as shown by a survey that noted that those plans with an auto enrollment feature. Fourth, if the QACA rules are followed, the QACA, like other safe harbor arrangements,  is exempt from the top heavy rules.

Auto enrollment plans also can take care of the "Where do I invest their money?" question, by establishing a Qualified Default Investment Alternative ("QDIA"), for those unable or unwilling to direct the investment of their own money.

Overall, the auto enrollment tool, coupled with the auto escalator provision, gives the traditional 401(k) plan, additional, positive and powerful tools to increase plan participation, avoid ADP/ACP discrimination testing, get an exemption from the top heavy burdens, and depending on the plan design, at little or no cost to the plan sponsor.

Finally, since all pre-approved 401(k) plans must be restated during the next two years, now may be a good time to review plan design and implement changes as part of the restatement process.



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