With the future of Social Security in question, it is becoming ever increasingly important for workers to self-prepare for post-retirement living. Studies show that approximately one out of every three eligible workers choose NOT to participate in their employer-sponsored 401(k) plan. Offering automatic enrollment in your 401(k) plan is a way for you, as Plan Sponsor, to help lend a hand to employees that are not fully aware of the significance of having a post-retirement source of revenue.
Plans with an automatic enrollment feature nearly doubled over the past decade according to the Plan Sponsor Council of America’s (PSCA) 60th Annual Survey of Profit Sharing and 401(k) Plans. PSCA, part of the American Retirement Association, found that 59.7 percent of plans had an automatic enrollment feature in 2016 compared to 35.6 percent in 2007. Having an automatic enrollment provision can also help allow Highly Compensated Employees (HCE’s) contribute more to the plan by either boosting the participation rate of Non-Highly Compensated Employees (NHCE’s) or by satisfying the Safe Harbor requirements which exempt the plan from certain nondiscrimination testing.
Your current plan document gives you the option to choose different levels of automatic enrollment, described in the following paragraphs.
Automatic Contribution Arrangement
The Automatic Contribution Arrangement (ACA) is the most basic of the automatic enrollment options and has existed since the late 1990’s. A 401(k) plan with an ACA provides for increased participation by stating that eligible employees will be automatically enrolled in the plan unless they elect otherwise. A beginning “default” withholding percentage or dollar amount is chosen by you as the Plan Sponsor. Employees have the right to choose not to have salary deferred, or to elect a percentage or dollar amount that is different from the default withholding.
If the ACA provision is newly added to the plan, you as the Plan Sponsor may elect to apply the automatic enrollment to existing participants or apply it solely to new employees moving forward. If your plan allows for Roth deferrals, the default withholding may be traditional pre-tax 401(k) or Roth-based. You even have the option of escalating the initial automatic deferral amount annually for employees, thus increasing their savings every year of employment.
In the event that a discretionary company match is offered, automatically-enrolled employees’ contributions are matched just as they normally would be for employees that voluntarily participate. Any discretionary contributions follow your plan’s regular vesting schedule.
Eligible Automatic Contribution Arrangement
The Eligible Automatic Contribution Arrangement (EACA) builds on the basic ACA. All aspects mentioned above also apply to EACA’s, with two primary additions:
- The plan has the option to choose to allow permissible withdrawals for employees that were initially automatically enrolled, but then elected not to participate in the plan.
- A window of 30-90 days may be chosen within the date of the first automatic deferral to allow participants who were automatically enrolled to “opt-out” and withdraw any money that was already withheld from their pay. Any associated company match would, in turn, be forfeited.
If your EACA plan covers all employees, the deadline to complete your ADP/ACP nondiscrimination testing and withdraw any necessary testing failure refunds without a penalty is six months following the close of the Plan year, rather than two and a half months following the close of a plan year for a non-EACA plan.
Qualified Automatic Contribution Arrangement
A Qualified Automatic Contribution Arrangement (QACA) combines automatic enrollment provisions with the IRS’ Safe Harbor provisions. Thus, QACA plans increase participation among employees while also making the plan exempt from certain nondiscrimination testing and allow HCE’s to maximize their annual 401(k) contributions. QACA provisions require a minimum of 3% automatic enrollment; however, certain annual escalations may be necessary such that by year five, an automatically enrolled employee must have at least a 6% contribution rate. You may opt to begin year one with 6% as the automatic enrollment percentage to avoid the required escalations, but in no event can the automatic withholding exceed 10% of annual compensation.
Unlike the other automatic enrollment arrangements, QACA plans have a required employer contribution. An employer must make at least a 100% matching contribution of salary deferrals up to the first 1% of compensation, plus a 50% matching contribution on the next 5% of compensation deferred, or a non-elective contribution equal to 3% of compensation to all eligible participants. Either of these contributions must be fully vested by the time an employee has completed two years of service.
Qualified Default Investment Alternative
All automatic enrollment options may elect a Qualified Default Investment Alternative (QDIA). The default fund is utilized when an employee does not make their own investment election but is entitled to a contribution in the plan — whether being their own salary deferrals, company funded contributions, and/or reallocated forfeitures. A QDIA requires an annual notice be provided to your employees, summarizing the plan’s QDIA selection.
The purpose of the QDIA is to minimize the risk of large losses and at the same time provide long-term growth. Choosing a QDIA offers liability relief to an extent for plan fiduciaries. Your investment advisor may be able to provide you with more details regarding what funds constitute a QDIA. While not required by law for an ACA, EACA, or QACA, most automatic enrollment plans do elect a QDIA for administrative convenience.
Challenges of Automatic Enrollment / Contributions
While automatic contribution can be utilized as a means of increasing participation in a retirement plan, this strategy should be discussed with a qualified plan consultant. There are several other considerations that should be taken into account to effectively determine if the solution best meets the objectives of the company and its employees.
- While auto enrollment tends to increase participation rates, studies have shown that it leads to lower contribution rates because the employers have set a low default contribution rate. By educating employees on the benefits of saving for retirement instead of using an opt out approach, you can increase participation rates as well as contribution rates.
- Administration for automatic contributions can be a burden for the employer as it involves various notices and opt-out procedures.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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