IRS Issues Final 401(k) Auto-Enrollment Regulations

• Minimum Deferral Contributions -- How to Calculate. IRS clarified that, in determining the minimum deferral percentage that applies to a participant under a QACA, one looks to the date the employee first had contributions made pursuant to a default election under the QACA. If an employee makes an affirmative election before default contributions begin, the "initial period" for the minimum contributions does not begin. Minimum contribution percentages are increased for plan years after the "initial period."
• Minimum Deferral Contributions -- One Year Rule. A plan may treat a participant who had no contributions under a default election for an entire plan year as if the employee had no contributions for any prior year. This would allow the plan, for example, where an employee is terminated and remains severed for an entire plan year, to treat the employee as incurring a new "initial period" if s/he fails to make an affirmative election under the QACA after rehire.
• Automatic Enrollment on Expiration of Affirmative Elections. Under a QACA, automatic enrollment applies for periods during which an affirmative election is not in effect. If a plan provides that an affirmative election expires (e.g., all elections expire at year end) and the participant fails to make an affirmative election after the expiration (e.g., an affirmative election to continue deferrals at the previously elected rate of contribution), the participant is automatically enrolled at the default percentage.
• Compensation for Determining Default Contributions. Effective for plan years beginning in 2010, the default deferral contributions must be based on a safe harbor definition of compensation under IRC § 414(s).
• Mid-Year Percentage Increases. The default deferral percentage must be applied uniformly. However, this does not necessarily prohibit mid-year increases in the default percentage. Final regulations make clear that mid-year increases are acceptable as long as the percentage is uniform based on the number of years or portions of years since the employee first had contributions made pursuant to a default election under the QACA.
• Timing of Notice. The QACA notice is deemed to satisfy the requirement that it be provided "within a reasonable period before each plan year" if it is provided at least 30 but no more than 90 days before the beginning of the plan year. Where an eligible employee is not provided notice during this period because s/he became eligible after the 90th day before the beginning of the plan year, the requirement is satisfied if notice is given no more than 90 days before the employee becomes eligible and no later than the day the employee becomes eligible to participate. If it is not practicable for the notice to be provided on or before the date the employee become eligible, notice will be treated as timely if it is provided as soon as practicable after that date and the employee is permitted to elect to defer from all types of compensation that may be deferred under the plan which is earned beginning on that date.
• Effective Date of Default Election. The default election must be effective no earlier than a reasonable amount of time after the employee's receipt of the notice. This is in order to provide the employee with a reasonable period of time to make an affirmative election. However, final regulations now require that the default election must be effective no later than the pay date for the second payroll period that begins after the notice is provided or, if earlier, the first pay date that occurs at least 30 days after the notice is provided.
• Only Employees Making Affirmative Election Excluded from QACA. Only employees who have an affirmative election in effect are permitted to be excluded from the QACA. Prior to the adoption of the QACA, sponsors may have permitted employees to "elect" not to contribute by not returning their election form. IRS was asked whether such employees could be treated as affirmatively electing a zero contribution and thereby excluded from automatic deferrals under the QACA. IRS rejected this appeal, reasoning that the explicit terms of IRC § 401(k)(13)(C)(iv)(II) require an affirmative election.
• No Hardship Withdrawal of Matching or Non-Elective Contributions. Final regulations clarify that the employer matching or non-elective contributions made under the QACA are safe harbor contributions and, as such, may not be withdrawn on account of hardship.
• Allocation of Matching or Non-Elective Contributions. Final regulations retain the requirement that the employer matching or non-elective contributions be made to each eligible employee under the plan -- not only those who are subject to a default deferral election under the QACA.

EACA Requirements

IRS highlighted the following changes that it made in the final EACA regulations.

• Employees Who Are Subject to the EACA. Final regulations allow flexibility in implementing an EACA. Proposed regulations had required that the automatic enrollment apply to all employees eligible to participate in the plan who do not have an affirmative deferral election in effect. This was changed in the final regulations, to apply the automatic enrollment only to those employees specified under the plan as covered employees under the EACA. Accordingly, the plan document must specify the employees who are covered under the EACA and must state whether an employee who makes an affirmative election remains covered under the EACA. Notices need to be provided only to those employees who are covered under the EACA. An EACA that does not cover all eligible employees under the plan, however, is not entitled to the extended 6-month correction period under IRC § 4979.
• Uniformity and Plan with Multiple EACAs. An EACA must provide that the default elective contribution is a uniform percentage of compensation. However, the final regulations now allow for more than one EACA in a plan. To harmonize the conflicting requirements, the final regulations provide that the uniform percentage requirement is applied by aggregating all EACAs within the plan. The definition of plan is determined after applying the disaggregation rules of Treasury Regulation § 1.401(k)-1(b)(4) -- that is, allowing permitted disaggregation of different groups of collectively bargained employees or different employers in a multiemployer plan.
• Mid-Year Implementation Prohibited. The final regulations make clear that an EACA may not be started in the middle of a plan year of an existing cash-or-deferred arrangement.
• Timing of Notice. Changes identical to those noted above for the QACA notices were also made for the EACA notices.
• 90-Day Permissible Withdrawal Period. Final regulations clarify that the plan may allow permissible withdrawals for a period of less than 90 days after the date of the first default elective contribution -- as long as the period is at least 30 days from that date. This clarification was in response to employer concern about inadvertently permitting withdrawals outside the maximum 90-day period.
• Permissible Withdrawals Not Limited to Automatic Enrollees. A 401(a) plan or 403(b) plan may not limit permissible withdrawals to those employees who are automatically enrolled and who do not subsequently make an affirmative election within the 90-day period. Their withdrawal right cannot be conditioned on their level of deferral election.
• Latest Day of Permissible Withdrawal. In a change from the proposed regulations, the permissible withdrawal election must now be effective no later than the pay date for the second payroll period that begins after the election is made or, if earlier, the first pay date that occurs at least 30 days after the election is made. (This provides greater flexibility. Under the proposed regulations, the deadline was no later than the last day of the payroll period that begins after the date the election was made.) The withdrawal must be made in accordance with the plan's ordinary timing procedures for processing distributions, and the plan cannot charge a higher fee for permissible withdrawals than it does for other distributions.

Compliance Review in Order

Given the current economic climate it is unlikely there will be a rush to implement new QACAs or EACAs for the 2010 plan year. However, the issuance of final regulations will provide greater certainty for plan sponsors choosing to do so. For QACAs already in existence, plan sponsors and administrator will want to bring the features in line with the final regulations as soon as possible given the retroactive effective date. In particular, they will want to:

• Confirm the QACA is applying the correct minimum contribution percentage, based on the employee's "initial period" as described in the regulation.
• Consider adopting the optional 1-year rule, by which employees with no default contributions for one full plan year are treated as incurring a new "initial period." This may be attractive for employers with many rehires.
• Confirm that, if deferral elections expire under the plan, the employee is subject to automatic enrollment if s/he fails to make a new affirmative election.
• Be aware of the definition of compensation now used to determine the deferral amount and, if it is not a safe harbor definition, prepare to convert to a safe harbor definition beginning with the 2010 plan. Various options exist in formulating a safe-harbor definition so preliminary discussions with the employer's payroll provider may be worthwhile.
• If the QACA applies mid-year increases in the default deferral percentage, confirm that the increases comply with the new requirements.
• Review the QACA notice timing. Confirm that the notice is provided at least 30 but no more than 90 days before the beginning of each plan year. For employees who become eligible in the 90-day period before the beginning of the plan year confirm that they are getting the notice at least 30 days before the beginning of the plan year -- if not, make sure they are getting the notice no later than the date they become eligible to participate (and not more than 90 days before that date). If it is not possible to provide the notice by the date the employee becomes eligible, make sure procedures are in place to provide it as soon as possible thereafter and the employee has an opportunity to make an affirmative election to defer with respect to all compensation that is earned beginning on the eligibility date.
• Confirm that default deferral elections are made effective no later than the pay date for the second payroll period beginning after the date the notice is provided or, if earlier, the first pay date occurring at least 30 days after the notice date.
• Confirm that employer matching and non-elective contributions are not being made available or hardship withdrawals.

With the greater lead-time for implementing the final EACA regulations -- which are not effective until he 2010 plan year -- it may be less of a priority to immediately confirm compliance. (According to the final regulations, a plan that operates in compliance with either the proposed or final regulation in the interim will be treated as operating in good faith compliance.) Nonetheless, plan sponsor and administrators may now want to:

• Examine whether it makes sense to utilize more than one EACA under the plan, or to limit the EACA to less than all eligible employees. In the case of different groups of collectively bargained employees this will likely make sense. It may make sense for single employers as well -- for example, limiting the EACA to employees who are hired after a fixed date and who do not make an affirmative election -- if it sufficiently minimizes the number of individuals required to receive notice and the plan does not need the extended 6-month correction period for ADP or ACP.
• Be aware that, if considering adding an EACA to an existing cash-or-deferred arrangement, it needs to be done at the beginning of a plan year.
• Consider whether it makes sense to limit the period for permissible withdrawals to less than 90 days after the date of the first default elective contribution. A 30-, 45- or 65-day limit may be sufficient and will bring the "uncertain" period to closure more quickly.
• Make sure that the participants who make an affirmative deferral election during the 90-day (or shorter) withdrawal period are nonetheless permitted to withdraw their automatic deferrals during that period.
• Make sure that the permissible withdrawal election is effective no later than the pay date for the second payroll period beginning after the election is made or, if earlier, the first pay date occurring at least 30 days after the election. Confirm that the plan's normal distribution procedures (e.g., timing, cost) are applied to the permissible withdrawals.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2009, Deloitte.

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