Automatic Enrollment

INTRODUCTION
Automatic Enrollment is an easy way for employees to start participating in their company plan and save for retirement.  Under this enrollment approach, compensation is automatically deducted each pay period unless the participant elects otherwise by completing the Plan’s enrollment form.

Automatic Enrollment has been utilized by plans for a number of years.  While the IRS issued guidance in 1998 giving a “thumbs-up” for these arrangements, some employers remained hesitant to adopt the feature.  The two most common concerns hindering widespread acceptance were: (1) whether state wage laws prohibit the withholding of an employee’s pay without their consent, and (2) to what extent plan fiduciaries remain liable for the default investment of the money automatically deposited into the plan without participant investment direction.    

The Pension Protection Act of 2006 (PPA) cleared the way for plans to consider automatic enrollment as a means of improving employee participation.  PPA removes the state wage law and default investment concerns, and they are no longer legal obstacles for employers considering automatic enrollment.  Furthermore, PPA allows employers to consider a Qualified Automatic Contribution Arrangement (QACA) beginning January 1, 2008.

Taking the automatic enrollment concept one step further, some employers have decided to design their plan with an Automatic Salary Deferral Increase feature.  The increase feature is an easy way for participants to increase the amount they contribute to the Plan on a regular basis.  The most common use of this feature provides that participants who are automatically enrolled at the default percentage of pay will have their contribution percentage amount increased by one percent each year until the maximum contribution percentage is met.

TYPES OF AUTOMATIC ENROLLMENT – There are 3 types of PPA automatic enrollment plan designs:

Automatic Contribution Arrangement (ACA):  The Employer adopts automatic enrollment and chooses a level of employee 401(k) deferral (3% of compensation is popular).  The employee may elect to defer a higher or lower percentage, or elect to not defer at all.  Should the employee fail to complete a 401(k) election form, the designated % of compensation must be deferred from pay upon their entry into the plan.
 
Eligible Automatic Contribution Arrangement EACA:  Designed like the ACA version discussed above, this version of an ACA provides 401(k) testing advantages for the employer.  In addition, an employee who is default enrolled can be given the option to take their money out of the plan within 90 days of enrollment.

Qualified Automatic Contribution Arrangement (QACA): This version of an ACA is a new form of 401(k) Safe Harbor and it offers the following features in addition to those described in the ACA and EACA paragraphs above:

    1. A required Employer Safe Harbor contribution which may be satisfied by providing either: (1) a non-elective contribution of 3% of compensation for all eligible employees, or (2) to those employees making 401(k) salary deferrals, a 401(k) match of 100% of the first 1% of compensation a participant defers and 50% of the next 5% of compensation deferred (for a maximum match of 3.5%).

    2. The Employer Safe Harbor Contribution may be subject to a 2-year vesting requirement.

    3. The Plan must automatically enroll employees at a minimum compensation percentage of at least 3%, and must automatically increase the employee’s deferral percentage by 1% each year (to at least 6% and no more than 10%) unless the employee elects otherwise.  Note: an initial automatic deferral percentage of 6% will not require the 1% increase feature to apply to the Plan.

    4. Because the Plan is “Safe Harbor” the Highly Compensated Employees may defer the maximum 401(k) amount allowed by law, regardless of the ADP of the Non-Highly Compensated Employees.

AUTOMATIC ENROLLMENT CANDIDATES – Plans that struggle with employee participation and have poor employee retirement income replacement projections are good candidates for automatic enrollment.  In addition, companies looking to take some of the decision making out of the hands of their employees and make it easier for them to contribute for retirement should find this feature to be a good solution.

Plans that struggle with employee participation for IRS nondiscrimination testing will generally find that an ACA or EACA improves the average Non-Highly Compensated Employee (NHCE) deferral rate, allowing greater contributions for the Highly Compensated Employees (HCE).  Including a Salary Deferral Increase feature should take employee saving to a new level.

Plans that are currently “Traditional” 401(k) Safe Harbor design may find the QACA to be a good plan design alternative.  The QACA feature will likely result in a lower company Safe Harbor contribution cost, especially in situations with sufficient employee turnover to take advantage of the new 2 year Safe Harbor contribution vesting schedule.

CHECKLIST OF ADDITIONAL AUTOMATIC ENROLLMENT ISSUES - While Automatic Enrollment should provide a number of measurable plan enhancements, employers should be mindful of some key issues before deciding to adopt the feature:

  • The Plan must offer a means by which the Participant is able to elect difference salary deferral percentage or elect not to participate.  A 401(k) enrollment/salary reduction form should be used for this purpose.  The 401(k) enrollment/salary reduction form should be distributed with the Employee Notice so employees have the ability to change their election.
  • Employees need to be notified of the features described above at enrollment (and annually thereafter), at least 30 days prior to the applicable entry date (or, for the annual notice, 30 days prior to the start of the plan year).  The Department of Labor has the authority to assess penalties of up to $1,100 per day for failure to provide the required Employee Notice.
  • The Plan needs to establish a Qualified Default Investment Alternative (QDIA) to receive the automatic contributions in lieu of the employee’s investment election.  This will likely require a discussion with your investment advisor in order to pick an appropriate QDIA for the plan.  The Department of Labor QDIA rules require specific disclosures to participants regarding the QDIA investment at enrollment and annually thereafter.
  • Employers need to be diligent in making sure employees are automatically enrolled and deferrals start on the proper entry date.  In addition, if an Automatic Salary Deferral Increase applies, the proper amount of salary withholding must take place on the applicable dates following employee entry into the plan.  This usually means discussing automatic enrollment with your payroll provider.  Based on the current IRS plan correction program, it appears that failure to automatically enroll an employee requires the company to make-up the missed contributions for the employee.
  • Companies who match 401(k) deferrals will want to consider the impact the feature may have on contribution costs to the plan if the percentage of employees contributing to the Plan increases substantially.  Certain Automatic Enrollment designs may or may not require employers, upon amending the plan, to apply the feature to existing employees that previously met eligibility but not currently contributing to the Plan.