A new safe harbor 401(k) plan option which can eliminate annual discrimination testing will be available for the first time in 2008. The new design may be attractive to employers who chose not to adopt a current law safe harbor plan as well as to employers who have 401(k) plans containing current law safe harbor and automatic enrollment provisions.
Choices in 2008
Beginning in 2008, employers will be able to choose from among the following:
- a traditional 401(k) plan, which requires cumbersome annual discrimination testing;
- a pre-2008 safe harbor plan, which was exempt from most discrimination testing but required higher employer contributions and full vesting of employer contributions; and
- a new “auto enrollment” 401(k) plan that can be designed to avoid all discrimination testing and that permits employer contributions to vest with up to two years of service.
In addition to being cumbersome, the results of annual discrimination testing may require plan sponsors to limit the contributions of highly paid employees, make additional contributions for employees who are not highly paid, or refund excess contributions after the end of the plan year to keep the plan qualified. Avoiding this testing will significantly simplify plan operations and may also save the plan sponsor money.
In addition to authorizing this new safe harbor plan, the Pension Protection Act of 2006 (PPA) provided relief from two legal concerns that had prevented some employers from adopting automatic enrollment plans: fiduciary responsibility for default investments and concerns about the possible application of state law restrictions on pay deductions. The PPA established that there is no fiduciary liability for default investments selected for participants who fail to make elections, so long as the fiduciaries comply with Department of Labor regulations. The PPA also clarified that the U.S. Employee Retirement Income Security Act preempts the application of state laws that would block automatic enrollment programs by requiring employee consent for pay deductions.
Basics of the New Plan Design
The basic requirements for the new "auto enrollment" safe harbor plan are as follows:
- Automatic contributions must be made for either new hires only or new and current employees, as selected by the plan sponsor, who do not affirmatively decline to contribute. It appears that the exemption from discrimination testing will be available even if automatic enrollment is available only to new hires. This represents a major advantage over currently permissible 401(k) plan designs.
- Employees must have the right to stop automatic contributions or change the level of their contributions and receive a refund of excess contributions, although they will forfeit any associated matching contributions.
- The automatic contribution may be no greater than 10% of compensation and no less than 3% of compensation in the first year. The minimum automatic contribution must be increased by 1% per year for each year up to the fourth year.
- The employer must make a matching contribution of up to 3 ½% of compensation (the current safe harbor may require a matching contribution of up to 4% of compensation) or a non-elective contribution of 3% of compensation.
- Employer contributions may vest after up to 2 years of service, whereas the current safe harbor requires immediate vesting of required employer contributions. As under current law, notice of plan provisions must be given to participants within a reasonable period prior to the beginning of each plan year in which the plan is a safe harbor plan. The PPA also specifically requires that this notice describe employees’ rights to elect out of contributions or change the rate of contributions, as well as the plan’s default investment provisions.
- Also as under current law, employer contributions to a safe harbor plan may not be withdrawn for in-service hardship.
Why Investigate Now?
Employers who want a safe harbor plan in place on January 1, 2008 must adopt the plan and notify employees during 2007. As always with new plan designs, there are technical questions about the details of the new rules and how employers may switch over to the new plan design. We have not yet seen regulations on the new rules; but, given the attractiveness of this new design and the level of employer interest, we anticipate that guidance for employers will be forthcoming. In the meantime, it makes sense to consider whether to adopt this new type of 401(k) p