On November 8, 2007, the Internal Revenue Service released proposed regulations (the “Proposed Regulations”) relating to automatic contribution arrangements (Click here for a copy of the Proposed Regulations.) While automatic contribution arrangements have been used by qualified plan sponsors for a number of years, section 902 of the Pension Protection Act (the “PPA”) added certain provisions to the Internal Revenue Code (the “Code”) to facilitate the use of automatic contribution arrangements in 401(k), 403(b), and 457(b) plans.

The Proposed Regulations contain amendments to the current regulations under Code sections 401(k), 401(m), 402(c), and 4979 to reflect changes made pursuant to the PPA. In addition, the Proposed Regulations contain new proposed regulations under Code section 414(w), which was added by the PPA. This Legal Alert will highlight and summarize key provisions of the Proposed Regulations relating to both Qualified and Eligible Automatic Contribution Arrangements, noting items that clarify the rules relating to qualified contribution levels, the design-based safe harbor from ADP and ACP testing, and the rules for withdrawing automatic contributions.


Under the provisions of the PPA, an automatic contribution arrangement is a cash or deferred arrangement that provides that, in the absence of an affirmative election by an eligible employee, a default contribution election is made on behalf of the employee, and the employee is treated as having made that election under the plan. The PPA provides for two categories of automatic contribution arrangements: Qualified Automatic Contribution Arrangements (QACAs) and Eligible Automatic Contribution Arrangements (EACAs).

Qualified Automatic Contribution Arrangements

A plan that satisfies the QACA requirements may take advantage of the ADP and ACP safe harbor by satisfying a nonelective contribution requirement that mirrors the current nonelective safe harbor under Code section 401(k)(12), or a matching contribution requirement that allows for a lower level of matching contributions than the current matching safe harbor. In addition, employer contributions made to a QACA are subject to a two-year vesting schedule, as opposed to immediate vesting under a traditional safe harbor arrangement.

In order to meet the requirements for a QACA, the Proposed Regulations provide that an automatic contribution arrangement first must meet the current rules for design-based safe harbors under Treas. Reg. §§1.401(k)-3 and 1.401(m)-3. Accordingly, the plan provision implementing a QACA for an existing plan must be adopted before the first day of the plan year and remain in effect for an entire 12-month plan year. The plan may also limit the amount of elective contributions made by an eligible employee under a QACA, as long as each Non-Highly Compensated Employee is permitted to make contributions that would allow him or her to receive up to the maximum matching contribution under the plan. The plan must also provide for certain minimum contribution percentage elections and provide certain notices to participants.

The Proposed Regulations address a number of the details surrounding the QACA requirements. With regard to the minimum qualified contribution percentage, the Proposed Regulations clarify that the initial period - during which minimum contribution rates must equal at least 3% of compensation - begins on the date that the employee first participates in the QACA and ends on the last day of the following plan year. While the qualified percentage for each subsequent year must increase by 1%, the Proposed Regulations also clarify that, to the extent that a QACA provides for an initial contribution percentage of more than 3%, the plan need not increase the automatic contribution percentage to an amount higher than the amount required for subsequent years under Code section 401(k)(13)(C)(iii). By way of example, the Proposed Regulations provide that if the plan provides for a minimum contribution percentage of 4% during the initial period, the plan would not be required to increase its minimum qualified percentage by 1% for the following plan year; it could continue to require a 4% contribution during the next year, but would then be required to raise the minimum qualified percentage to 5% in the following year and 6% thereafter (the percentage cannot exceed 10%).

With regard to default elective deferrals, the Proposed Regulations clarify that a default election under a QACA ceases to apply to any eligible employee if the employee makes an affirmative election to opt out of the automatic contribution arrangement, or to have elective contributions made on his or her behalf in a specified amount. In addition, the Proposed Regulations clarify that the default election rules do not apply to employees who, immediately before the effective date of the QACA, have completed an election form and chosen either not to contribute to the plan or to contribute at a chosen amount or percentage. Employees who have not actually completed an election form must be included in the default enrollment scheme.

With regard to the uniformity requirement, the Proposed Regulations also clarify that the minimum qualified percentage may vary for participants, taking into account factors such as the number of years of participation in the QACA, the rate of elective contributions under the plan as of the effective date of the QACA, and applicable limits under Code sections 401(a)(17), 402(g), or 415. In addition, a QACA may delay enrollment of a participant who has been suspended from making contributions for 6 months following a hardship withdrawal; however the plan must provide that, at the end of the suspension period, elective contributions will resume at the percentage that would apply if the suspension had not occurred.

Finally, with regard to notices required under a QACA, the Proposed Regulations clarify that the initial notice must provide the same information that is required for current design-based safe harbor plan notices under Code section 401(k)(12). In addition, the QACA notice must explain the employee’s right to opt out of the QACA or to have contributions made in a different amount, and the notice must describe how automatic contributions will be invested in the absence of any investment direction by the employee. Like the current design-based safe harbor notice, the QACA notice will be deemed timely delivered if it is provided to each eligible employee at least 30 days, but no more than 90 days, before the beginning of the plan year. The timing requirement is satisfied for new eligibles if the notice is provided no more than 90 days before the employee becomes eligible under the QACA, and no later than the date that the employee becomes eligible.

Eligible Automatic Contribution Arrangements

A plan that contains an EACA is provided certain limited relief from the distribution restrictions under Code sections 401(k)(2), 403(b)(7) and (11), and 457(d). Specifically, the employee can be permitted to elect to receive a distribution of automatic contributions made during the first payroll period and any succeeding payroll periods beginning before the effective date of the election without paying any additional tax under the provisions of Code section 72(t). Under Code section 414(w)(2)(B), the election to withdraw contributions made under the EACA must be made within 90 days of the “first elective contribution with respect to the employee under the arrangement.”

The Proposed Regulations clarify the Code section 414(w) rules in several respects. First, the Proposed Regulations would define the term “arrangement” to mean the EACA, as opposed to the plan. Accordingly, only those contributions made after an automatic contribution arrangement became an EACA are eligible for withdrawal under the unwind provisions of Code section 414(w)(2)(B). Because an automatic contribution arrangement cannot “become” an EACA until after the effective date of the automatic contribution provisions of the PPA (January 1, 2008), automatic contributions made prior to that date are not eligible for withdrawal pursuant to section 414(w). Second, the Proposed Regulations also clarify that the 90-day window for making the withdrawal election begins on the day that the compensation made the subject of the automatic contribution would otherwise have been included in the employee’s gross income. This means that employers must begin counting the 90-day period from the payment date of the associated compensation, as opposed to the date in which the contribution is deposited into the trust, or the date that the contribution is invested pursuant to the plan. Finally, the Proposed Regulations state that the “effective date” of the election must be no later than the last day of the payroll period that begins after the date that the election was made. Accordingly, an election to withdraw an automatic contribution that is made during the course of a payroll period may apply to contributions made before or during that payroll period, but not after.

Note that the Proposed Regulations provide employers with certain options with regard to the Code section 414(w) distribution feature. If an employer opts to include a section 414(w) feature in the plan, the employer is not required to make the option available to all employees eligible under the EACA. Accordingly, an employer may opt to make the feature available to employees eligible to participate in the plan prior to the EACA effective date, but not to new plan entrants. However, the Proposed Regulations make clear that a 401(k) or 403(b) plan sponsor may not condition the right to take a Code section 414(w) distribution on the employee’s waiver of the right to make future elective contributions. This condition would be impermissible under the universal availability rule (as applicable to 403(b) plans) or the contingent benefit rule (as applicable to 401(k) plans).

The Proposed Regulations also provide details regarding the process for returning contributions to employees pursuant to Code section 414(w). Under the Proposed Regulations, the amount distributed to the participant upon a withdrawal election would be the amount of the participant’s account balance attributable to default elective contributions, adjusted for gains and losses. The amount would be reported on Form 1099-R at the end of the year, but, again, would not be subject to the additional income tax under section 72(t). Under the Proposed Regulations, such amounts would not be eligible for rollover and would not be taken into account for the purpose of ADP and ACP testing. Matching contributions associated with returned EACA contributions must be forfeited. The Proposed Regulations provide that such forfeited amounts cannot be returned to the employer or distributed to the employee as taxable compensation. Instead, such amounts must remain in the plan and must be treated in the same manner as other plan forfeitures. Furthermore, because the PPA lengthened the 2½-month correction period for excess contributions and excess aggregate contributions under an EACA to 6 months, the Proposed Regulations clarify that the section 4979 excise tax will not apply to excess contributions or excess aggregate contributions that are returned within this 6-month period.

A plan with an automatic contribution provision need not satisfy the QACA design-based safe harbor rules in order for an employee to avail himself of the distribution relief afforded under section 414(w)(2)(B). In addition, the preamble clarifies that an employee’s affirmative election to opt out of an automatic contribution arrangement is not the same as an election to withdraw automatically contributed amounts under section 414(w). Thus, the employee who opts out of automatic contributions will need to make a second affirmative election to receive the contributed amounts; otherwise, those amounts remain in the plan.

Coordinated Notice Requirements

The preamble to the Proposed Regulations notes that the PPA provides for several notices related to automatic contribution requirements, including notices required under Code provisions and provisions of ERISA. The preamble states that the Internal Revenue Service plans to coordinate with the Department of Labor on these requirements and anticipates that a single document will satisfy all of the applicable notice requirements. This provision is a welcome acknowledgement of the administrative burdens associated with providing multiple notices to participants in automatic contribution arrangements.

Effective Date and Comments

The Proposed Regulations are effective for plan years beginning after January 1, 2008. Employers may rely on the Proposed Regulations until final regulations are issued. Written or electronic comments and requests for a public hearing must be received by February 6, 2008.