The Pension Protection Act of 2006 codified the implementation and operation of Automatic Contribution Arrangements in defined contribution plans, more commonly referred to as “Automatic Enrollment.” In late 2007, the Internal Revenue Service issued proposed regulations regarding these Automatic Contribution Arrangements. For a general overview of the proposed regulations and an explanation of the different types of automatic contribution arrangements, please see our news bulletin, “IRS Guidance on Automatic Contribution Arrangements” (12/17/07).
On February 24, 2009, following consideration of many questions and comments, the IRS published its final regulations on Automatic Contribution Arrangements. Many of the issues addressed in the proposed regulations are either confirmed or clarified in the final regulations. Only minor changes have been made to the general provisions of the IRS guidance. This article highlights key points of the final regulations that could potentially affect current or future Automatic Contribution Arrangements.
Changes in the Final Regulations Dealing with QACAs
1. In order to maintain a Qualified Automatic Contribution Arrangement (”QACA”), plan sponsors are required to ensure that plan participants contribute the minimum contribution percentage amount for the initial plan year and each subsequent year until the participant either opts out of the QACA, elects a different contribution percentage or reaches a minimum contribution percentage of 10%. The final regulations clarify two aspects of this requirement.
- In determining the participant’s minimum contribution percentage, the initial plan year for each participant is the first year in which the participant has compensation taken out of such participant’s paycheck and deferred under the default arrangement.
- Many commentators asked the IRS for clarification in determining the minimum contribution percentage for a rehired employee. The final regulations state that a rehired employee should generally be placed back into the plan at the minimum contribution percentage that would have applied if such employee had not left employment. However, if the employee had not been employed for more than one year, the final regulations make clear that plan sponsors are permitted to automatically enroll the rehired employee at a minimum contribution percentage as if he was a brand new employee.
2. Plan sponsors of QACAs are required to automatically enroll all eligible employees who do not have an affirmative election on file. Several commentators asked whether plan sponsors could set a limit on the length of an affirmative election, effectively giving each affirmative election an expiration date.
The final regulations permit plan sponsors to set an expiration date for all affirmative elections. The final regulations also allow a plan sponsor to, upon such expiration date, automatically enroll in the plan all employees who did not make a second affirmative election, effectively allowing plan sponsors to re-enroll those employees every year. As an example, if a plan sponsor begins a QACA and automatically enrolls all participants as of January 1, 2010, the sponsor can provide that all affirmative elections not to participate in the plan expire on December 31, 2010. The plan sponsor can then re-enroll in the QACA all eligible employees who made an affirmative election for the 2010 plan year, but neglected to make a second affirmative election for the 2011 plan year. Plan sponsors could do this every year.
3. Another condition for providing a QACA to plan participants is that proper notice must be given to each eligible employee within a reasonable period before the beginning of each plan year. In the case of new hires, the proposed regulations required that notice be given no less than 30 days prior to the date the first automatic contribution was made to the participant’s account. Many commentators expressed the impracticality of this provision in cases where new hires are immediately enrolled in the plan upon hire.
The final regulations now provide that if the provision of a notice to new hires before they become eligible is impractical, notice can be given “as soon as practicable after” eligibility as long as the employee is permitted to defer from all types of compensation that can be deferred from under the plan which the participant earns beginning on the participant’s hire date.
4. The final regulations also confirm that QACAs are required to be established for a complete plan year. However, several exceptions to this requirement exist. For example, the final regulations permit a newly adopted plan to establish a QACA mid-year.
Changes in the Final Regulations Dealing with an EACA
The proposed regulations outlined the conditions for implementing an Eligible Automatic Contribution Arrangement (“EACA”) under a plan. An EACA generally allowed participants who were automatically enrolled in a plan to opt out of the plan and withdraw automatic contributions made on their behalf within a permissible withdrawal period of 90 days from the date of the first such contribution to the plan. This provision allows a window for those employees who fail to submit their paperwork to opt out prior to the first automatic contribution is made to recoup the amounts automatically deferred under the arrangement without incurring a penalty tax.
The final regulations allow plans to implement an EACA, but also allow plans to then elect to shorten the permissible withdrawal period from 90 days to a period no shorter than 30 days. Also, the final regulations permit plan sponsors to charge those employees who elect to withdraw amounts during the permissible withdrawal period a fee not to exceed the same type of fee charged to participants who take other distributions under the plan.
Final Regulations Dealing with Changes Affected By WRERA
The final regulations also cite several provisions from the Workers, Retiree and Employer Recovery Act of 2008 (“WRERA”) that relate to the operation of Automatic Contribution Arrangements. The most notable change that WRERA makes affects the requirements for an EACA. While the proposed regulations required that amounts contributed under an EACA (absent participant investment direction) be invested in a qualified default investment alternative (“QDIA”), WRERA eliminated that requirement for EACAs.
The provisions of the final regulations that cover QACAs are generally applicable retroactively beginning with plan years commencing on or after January 1, 2008. The provisions of the final regulations that govern EACAs are generally applicable for plan years commencing on or after January 1, 2010. However, however, plan sponsors are required to comply in good faith with the final regulations for the 2008 and 2009 plan years for EACAs.