Due to increasing concerns about low levels of voluntary retirement plan savings, Congress passed new statutory incentives as part of Pension Protection Act of 2006 (PPA), to encourage plans to use automatic enrollment of employees into salary reduction savings plans for years beginning on or after January 1, 2008. Types of plans eligible for the new safe harbor provisions include: 401(k) profit sharing plans, 403(b) tax-sheltered annuity plans and 457(b) governmental eligible deferred compensation plans. The IRS has issued proposed regulations governing the rules applicable to these arrangements, and the Department of Labor has issued final regulations on Qualified Default Investment Alternatives (QDIAs), discussed in another article in this Update “Now Available: Qualified Default Investment Arrangements.”
Requirements for a Qualified Automatic Contribution Arrangement (QACA) allowing plan sponsors to be exempt from nondiscrimination tests and top-heavy minimum contributions include the following:
- Notice – Employers must notify employees about their right to opt out of the plan or to change their deferral amounts and investment allocations and what the default investment will be if they fail to do so. Notice must be given between 30 and 90 days before the start of the plan year in which the automatic enrollment takes effect. The IRS recently published a sample notice that can be used for this purpose at www.irs.gov/pub/irs-tege/samplenotice.pdf.
- Eligibility – New employees must automatically be enrolled subject to the right to withdraw or to elect not to participate. By plan design, employers can decide whether current employees who are not deferring into the plan will be subject to automatic enrollment.
- Qualified Deferral Percentages – The initial automatic deferral must be set at a minimum of between 3% to 10% of pay and must escalate at a rate of at least 1% per year so that the employee is deferring at least 6% after the third year.
- Company Contribution (note differences from current 401(k) safe harbors) – Employers must make either a matching contribution of 100% of the non-highly compensated employees’ contributions up to 1% of pay and 50% of non-highly compensated employees’ contributions over 1% but not exceeding 6% of pay (total exposure 3.5%). Employers can match highly compensated employees at the same or lower level. Contributions in excess of 6% may not be matched. In the alternative employers can provide a non-elective company contribution of at least 3% of pay for non-highly compensated employees. In either case, company contributions must be vested after not more than two years of service. Employer QACA contributions (like current 401(k) safe harbor contributions) are not distributable until termination of employment, death or disability.
Employers that currently have automatic contribution arrangements, or employers wishing to adopt automatic contribution arrangements that do not satisfy these requirements, may still do so as a means of increasing participation but will continue to be subject to annual nondiscrimination testing and top-heavy minimum requirements. Under the PPA amendments, the period within which to perform the tests and make corrective contributions or withdrawals is extended from March 1 for a calendar-year plan (2.5-month rule) to six months after the end of the plan year (June 30 for a calendar year plan) for any “Eligible Automatic Contribution Arrangement” (EACA). Both QACAs and EACAs may permit employees automatically enrolled to revoke the enrollment within the first 90 days and receive a refund of deferred amounts as current taxable compensation without the 10% early distribution penalty excise tax.
Current Safe Harbors or QACA?
Small employers wishing to maximize deferral and matching contributions for highly compensated employees and owners should compare the two arrangements. For companies with high turnover rates, the new QACA rules may be more beneficial due to the allowable two-year vesting provision on employer contributions (current safe harbor contributions must be fully vested immediately) and the exemption from top-heavy minimum contributions.