Inertia. Webster’s Dictionary defines it as “the lack of movement or activity especially when movement or activity is wanted or needed.” Plan sponsors and retirement committees often struggle with 401(k) plan participation inertia. Employees who fail to enroll in 401(k) plans when first eligible often neglect to commence participation. Employees who initiate elective deferrals at low rates regularly continue that trend. Low participation and deferral rates not only harm affected employees, but they also represent lost opportunities for employers. Higher participation and deferrals rates often bring with them a number of upsides, including increased plan assets that may create the opportunity for lower plan fees and more favorable nondiscrimination testing results allowing higher paid employees to make greater pre-tax deferrals.
Luckily, plan sponsors have a quiver in their bow to combat inertia – automatic enrollment. Automatic enrollment is a mechanism under which an eligible employee who does not make an affirmative election to make pre-tax contributions to a plan is automatically enrolled in the plan at a specific pre-tax contribution percentage, unless the employee specifically opts out. Automatic enrollment features are not new to the 401(k) plan world, but the Pension Protection Act of 2006 (“PPA”) added provisions designed to encourage sponsors of 401(k) plans to add an automatic enrollment feature.
Automatic Contribution Arrangements
Two types of automatic contribution arrangements were created by the PPA: an eligible contribution arrangement (“EACA”) and a qualified automatic contribution arrangement (“QACA”). Below is a brief description of each arrangement. Plan sponsors and committees should be advised that these arrangements contain a number of technical requirements (e.g., notice timing and content requirements) and it is advisable to confer with benefits counsel regarding these requirements prior to implementation.
An EACA is an automatic contribution arrangement that is exempt from certain distribution restrictions that normally apply to 401(k) plans. A participant who is automatically enrolled in an EACA is entitled to a 90 day period to revoke the automatic enrollment and receive a withdrawal of the elective deferrals that were made on the participant’s behalf (plus earnings). The withdrawn amounts are includible in the participant’s income, but not subject to the 10% early withdrawal penalty. Plans that adopt EACAs also are able to distribute excess contributions and excess aggregate contributions to correct failed actual deferral percentage (“ADP”) and actual contribution percentage (“ACP”) tests within 6 months after the end of the plan year in order to avoid a 10% excise tax payable by the employer (this period is normally 2-1/2 months).
To qualify as an EACA, a notice must be provided to participants prior to enrollment and annually thereafter. While many plan sponsors automatically enroll employees at a 3% deferral rate, there is no required initial deferral rate to qualify as an EACA. They may be designed to automatically increase the deferral rate in subsequent years of participation.
QACAs are automatic enrollment arrangements similar to EACAs but with the added benefit of including a nondiscrimination safe harbor. A plan that includes a QACA will be exempt from the ADP and ACP tests that otherwise limit the elective deferrals and matching contributions that may be received by highly compensated employees. To qualify as a QACA, a plan must satisfy the following additional requirements:
• The automatic contribution must be at least 3% the first year (and increase from 3% to 6% over the next three years). Higher contribution levels are permissible, but may not exceed 10%.
• The plan must include a “safe harbor contribution.” The contribution may be a nonelective contribution of at least 3% of compensation or a matching contribution that satisfies certain minimum requirements.
• Notice regarding the QACA must be provided to eligible employees prior to enrollment and before each plan year.
Provided the requirements of Section 404(c) of ERISA are satisfied, 401(k) plan fiduciaries generally are protected from claims of fiduciary liability that might arise out of the performance of investment options selected by a participant. The PPA provides plan fiduciaries with similar relief for automatically enrolled participants who are placed in default investments provided the default investment satisfies the requirements to be a qualified default investment alternative (“QDIA”). QDIAs are often target-date funds, but the regulations specify other permissible options as well. QDIA notices describing the arrangement must be provided prior to the initial investment and annually thereafter.
Many of us learned about inertia in elementary school science class. We learned that matter stays at rest unless acted upon by an external force. Automatic contribution arrangements are not the solution for all retirement plans, but they can serve as that external force to initiate participant action. Plan sponsors and retirement committee members are well-advised to consider inertia’s impact on retirement plan performance and the potential benefits of automatic enrollment.
"Automatic enrollment features are not new to the 401(k) plan world, but the Pension Protection Act of 2006 (“PPA”) added provisions designed to encourage sponsors of 401(k) plans to add an automatic enrollment feature.”