Employers that are contemplating or currently provide a QACA or EACA plan should review their plan documents and administrative processes for compliance with these final regulations.
The Internal Revenue Service issued final regulations on qualified automatic contribution arrangements (QACAs) under Section 401(k)(13) of the tax code and eligible automatic contribution arrangements (EACA) under Section 414(w) of the tax code. QACAs and EACAs are two types of automatic contribution arrangements created under the Pension Protection Act of 2006. Under an automatic contribution arrangement, a participant is automatically enrolled in the Section 401(k) plan at a specified default contribution percentage unless the participant affirmatively declines enrollment or enrolls at a different contribution level. The final regulations do not affect an automatic contribution arrangement unless this arrangement is intended to be a QACA or EACA.
The final regulations retained one important aspect of the proposed regulations, requiring that both QACAs and EACAs be adopted prior to the beginning of a plan year. In other words, neither a QACA or EACA may be adopted mid-year. Although retaining this feature of the proposed regulations, the final regulations adopted numerous other changes from the proposed regulations for both QACAs and EACAs as described in more detail below.
Modifications Affecting EACAs
The final regulations clarified several aspects that relate to implementing an EACA and aspects that relate to permitted withdrawals from an EACA. An EACA generally has two distinguishing features. First, an EACA plan may allow an automatically enrolled participant to withdraw his or her initial contributions made within the first 90 days after the compensation would have been included in income. Second, if an EACA plan fails the actual deferral percentage (ADP) test or the actual contribution percentage (ACP) test under Sections 401(k) and 401(m) of the tax code, an EACA plan can make corrective distributions up to six months after the end of the plan year, rather than the customary two and a half months after the end of the plan year, without incurring the 10 percent employer excise tax.
Implementing an EACA
Like the proposed regulations, the final regulations provide that an EACA plan must annually notify employees of the automatic enrollment features between 90 to 30 days before the plan year begins. The final regulations clarify that the required EACA notice will be timely if provided to a newly eligible employee at least prior to the pay date for first payroll period that the employee becomes eligible.
In order to implement an EACA, the final regulations add a new requirement that the plan document designate the specific employees covered by the EACA. Although the plan document can provide that employees who make an affirmative deferral election are no longer covered by the EACA and thus no longer need to receive the annual EACA notice, an EACA plan can utilize the extended six-month period for correcting ADP and ACP failures only if all eligible employees receive the EACA notice and are covered under the EACA for the entire plan year.
The final regulations allow an EACA plan to establish separate EACAs for groups that must be separately tested for nondiscrimination purposes, such as collectively bargained employees and employees of different employers in a multiple employer plan. This clarification allows an EACA plan to apply different default contribution levels for union and non-union employees.
Withdrawals from an EACA
An employee covered under an EACA may elect to withdraw default contributions within 90 days after the first default contribution would have otherwise been included in income. Under the final regulations, the EACA plan may adopt a shorter withdrawal election period as long as the election period is at least 30 days. The final regulations also allow a rehired employee who is re-enrolled in a plan at a default contribution level to withdraw new default contributions as long as the rehired employee had not made default contributions for at least a full plan year.
The final regulations also clarify that the withdrawal of default contributions under an EACA plan should be processed per the plan’s normal withdrawal rules, with one exception. The EACA withdrawal must be effective no later no later than the earlier of the pay date for the second payroll after the withdrawal election, or the first pay date occurring at least 30 days after the withdrawal election. If an EACA withdrawal occurs, and if a matching contribution previously was made on withdrawn amounts, then the corresponding matching contribution must be forfeited and must be adjusted for allocable gains or losses. In addition, the final regulations allow an EACA plan to make no matching contributions on withdrawn amounts if the deferral contribution is withdrawn before the matching contribution is made.
Modifications Affecting QACAs
A QACA plan is a type of automatic contribution arrangement that is deemed to automatically satisfy the ADP and ACP tests because it mandates automatic default contributions for eligible employees at specified levels and because it meets certain QACA notice, employer contribution and other requirements. With regard to required matching and non-elective contributions under a QACA, the final regulations clarify that these contributions are ineligible for a hardship withdrawal. In addition to clarifying withdrawals, the final regulations provide more details on requirements that relate to QACA elections and contributions and to QACA notices.
Notices Under a QACA
A QACA plan must provide each eligible employee a notice of automatic default enrollment and default investment within a reasonable period before each plan year. For a newly eligible employee, the final regulations provide that the QACA notice is timely if it is provided before the pay date for the first payroll period in which the employee becomes eligible to participate in the plan. With regard to any automatic default enrollment that follows the QACA notice, the default contribution must be effective no later than the earlier of the pay date for the second payroll period beginning after the date the notice is provided, or the first pay date that occurs at least 30 days after the notice is provided.
Elections and Contributions Under a QACA
The final regulations dictate that any matching or non-elective contributions made under a QACA must be based on a definition of compensation that meets the prescribed requirements of Section 414(s) of the tax code and that does not discriminate in favor of highly compensated employees. This new contribution requirement is effective for plan years beginning on or after January 1, 2010. In addition, matching contributions and non-elective contributions that are based on employee contributions for a full year must include all compensation earned after the participant became eligible under the plan, which could include compensation prior to the date of the employee’s first default contribution or first other elected contribution.
In calculating contributions, a QACA plan may provide that an employee’s prior affirmative election expires, allowing the QACA plan to automatically enroll the employee unless the employee makes a new subsequent election to decline enrollment. The QACA plan also may increase the default contribution percentage in the middle of the plan year, as long as the default contribution percentage for all participants is uniform based on the number of years or partial years since the employee’s first default contribution. This allows a plan to increase the default contribution percentage to coincide with mid-year salary increases or performance evaluations. The final regulations clarify that scheduled increases to the default contribution percentage apply regardless of whether the employee is eligible to make deferral contributions. For example, if a scheduled increase in automatic default contributions occurs during the six-month suspension following a hardship distribution, then the QACA plan applies the higher default contribution percentage following such suspension. Finally, a QACA plan may apply the default contribution percentage applicable to a new employee to a rehired employee, provided that the rehired employee made no default contributions for an entire plan year.
Effective Dates and Next Steps
Generally, except as noted above, the final regulations relating to QACAs apply for plan years beginning on or after January 1, 2008. The final regulations relating to EACAs apply for plan years beginning on or after January 1, 2010. Prior to the 2010 plan year, the plan must operate in accordance with good faith interpretation of the EACA requirements and may rely on either the proposed regulations or the final regulations.
Employers that either are contemplating or currently provide a QACA or EACA plan should review their plan documents and administrative processes for compliance with these final regulations. In many cases, plan amendments will be needed to comply with the final regulations or to take advantage of additional flexibility available under the final regulations.