401(k) Plan Design and Automatic Features
An automatic contribution arrangement (also known as automatic enrollment) is a feature in a retirement plan that allows an employer to “enroll” an eligible employee in the employer’s plan unless the employee affirmatively elects otherwise. “Enroll” in this context means that part of the employee’s wages are contributed to the retirement plan on the employee’s behalf. Most commonly, this feature is in 401(k) plans, but it can also be included in the following types of plans that permit employees to make elective contributions:
403(b) plans;
457(b) plans maintained by governmental employers;
SARSEPs; and
SIMPLE IRA plans.
HOW DOES AN AUTOMATIC CONTRIBUTION ARRANGEMENT WORK?
The employer automatically reduces an employee’s wages by a default percentage stated in the plan and contributes that amount to the employee’s plan account as an automatic contribution. The employee may affirmatively choose not to contribute at the plan’s default percentage rate or to contribute a different amount. The employee is 100% vested in his or her automatic enrollment contributions.
Generally, most plans will deduct automatic contributions from an employee’s pre-tax wages. This means that the amounts deducted are not included in the employee’s taxable wages or subject to income tax withholding requirements. However, 401(k) and 403(b) plans that accept designated Roth contributions can specify that the automatic contributions will be designated Roth contributions, which means they are deducted from an employee’s after-tax wages. An employer must deposit an employee’s automatic enrollment designated Roth contributions into a designated Roth account.
THE BENEFITS OF OFFERING AN AUTOMATIC CONTRIBUTION ARRANGEMENT
An automatic contribution arrangement encourages employees to begin contributing to the plan as soon as they are eligible to join that plan and start saving for their retirement. It is also an effective way for an employer to increase participation in its retirement plan and make it easier for that plan to pass required annual non-discrimination testing.
DIFFERENT TYPES OF AUTOMATIC CONTRIBUTION ARRANGEMENTS
Yes, besides the basic automatic contribution arrangement mentioned, which has been available for quite some time, more recent legislation introduced two new types of automatic contribution arrangements: an Eligible Automatic Contribution Arrangement (EACA); and a Qualified Automatic Contribution Arrangement (QACA).
An EACA, available for plan years beginning after 2007, is a type of automatic contribution arrangement that must uniformly apply the plan’s default percentage to all employees after providing them with a required notice. It may allow employees to withdraw automatic contributions (and earnings) by making a withdrawal election as required by the terms of the plan (no earlier than 30 days or later than 90 days after the employee’s first automatic contribution was withheld from the employee’s wages). Employees are 100% vested in their automatic enrollment contributions.
A QACA is available for 401(k) plans for years beginning after 2007. It is an automatic contribution arrangement with special “safe harbor” provisions that exempt the 401(k) plan from annual Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) non-discrimination testing requirements. A QACA must specify a schedule of uniform minimum default percentages starting at 3% and gradually increasing with each year that an employee participates. Under a QACA, an employer must make a minimum of either:
a) a matching contribution of 100% of an employee’s contribution up to 1% of compensation, and a 50% matching contribution for the employee’s contributions above 1% of compensation and up to 6% of compensation; or
b) a nonelective contribution of 3% of compensation to all participants, including those who choose not to contribute any amount to the plan. Under a QACA, employees must be 100% vested in the employer’s matching or nonelective contributions after no more than 2 years of service. A QACA may not distribute any employer contributions listed in a) and b) due to an employee’s financial hardship. As with the basic Automatic Contribution Arrangement, an employee can affirmatively elect not to have automatic enrollment contributions deducted from his or her wages.
HOW CAN AN EMPLOYER ADD ONE OF THE AUTOMATIC CONTRIBUTION ARRANGEMENTS TO AN EXISTING RETIREMENT PLAN?
An employer may add an automatic contribution arrangement feature to its plan simply by amending the plan to state that it will use an automatic contribution arrangement. Generally, the amended plan would need to specify:
- the plan’s default percentage rate for automatic enrollment contributions;
- the employee’s right to elect not to contribute to the plan;
- the employee’s right to elect to contribute an amount different from the plan’s default percentage rate for automatic enrollment contributions;
- the procedures for how an employee can elect not to contribute or contribute an amount different from the plan’s default percentage rate for automatic enrollment contributions;
- how an employee’s automatic enrollment contributions will be invested if the employee does not make an investment election, if an investment election is permitted by the plan;
- the procedures to be used to give the required automatic contribution arrangement notice to both existing plan participants, if covered, and new employees eligible to join the plan; and
- the additional requirements applicable if the plan chooses to add an Eligible Automatic Contribution Arrangement (EACA) or a Qualified Automatic Contribution Arrangement (QACA), both of which generally cannot be added to a plan mid-year.
The employer would then apply the automatic contribution arrangement to the employees as specified in the amended plan. The employer would also need to have employee election forms available for all employees covered by the automatic contribution arrangement.
WHAT NOTICES ARE NEEDED TO BE PROVIDED TO EMPLOYEES FOR AN EACA OR QACA?
The notice must be comprehensive and sufficiently accurate to inform employees of their rights and obligations under the retirement plan’s particular type of automatic contribution arrangement and must be understandable by the average employee.
An EACA notice must contain an explanation of the following:
- the plan’s default percentage rate for automatic enrollment contributions;
- the right to not participate;
- how to elect to not participate;
- how to elect to contribute an amount different from the plan’s default percentage rate for automatic enrollment contributions;
- how to make an investment election, if permitted by the plan;
- how automatic enrollment contributions will be invested in the absence of an employee’s investment election, if the plan permits employees to elect investments; and
- if allowed by the plan, how and when to withdraw any automatic enrollment contributions.
A QACA notice must explain the following:
- the plan’s default percentage rate for automatic enrollment contributions, including the amount and timing of any increases;
- the type and amount of the employer contributions;
- the right to not participate;
- how to elect to not participate;
- how to elect to contribute an amount different from the plan’s default percentage rate for automatic enrollment contributions;
- how to make an investment election, if permitted by the plan; and
- if the QACA contains two or more investment options, how automatic enrollment contributions will be invested in the absence of an employee’s investment election.
WHEN MUST AN EMPLOYER PROVIDE NOTICE OF THE EACA OR QACA?
The employer must notify all employees who are eligible to participate in the arrangement between 30 and 90 days prior to the beginning of each plan year. For plans that automatically enroll employees immediately upon being hired, an employer may give employees the notice on their date of hire. If it is not practical to give the notice before an employee becomes eligible, the plan can still meet the notice timing requirements by:
- giving notice to the employee before the pay date for the pay period in which the employee becomes eligible; and
- allowing the employee to make deferrals from any compensation he or she received after becoming eligible.
WHO SHOULD RECEIVE A QDIA NOTICE?
QDIA regulations do not specify to whom the annual notice should be given to; therefore the safest approach is to provide the notice to all eligible employees. It is also a more conservative approach to provide a notice to all eligible participants since a default investment could be needed at a variety of times and under a variety of circumstances, and the employer will be better protected if the notice is provided to all participants. The notice should be carefully worded to explain that it applies only if the participant has not selected his or her investment options and thus has been defaulted into the QDIA investments as a result of not making a selection.
According to the final QDIA regulations, the notice must be provided:
- (a) At least 30 days in advance of the date of plan eligibility, or at least 30 days in advance of the date of any first investment in a QDIA; or
(b) On or before the date of plan eligibility provided the participant has the opportunity to make a permissible withdrawal (90-day withdrawal under Section 414(w) of the code); AND - (ii) Within a reasonable period of time of at least 30 days in advance of each subsequent year.
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