In my third blog focused on automatic enrollment, I want to discuss the different types of automatic enrollment designs and provide you some thoughts on each type. To read my previous blogs in this series, click here for the participant perspective and click here for the employer perspective.
For this blog, let’s review the three types of automatic enrollment and some thoughts on each.
According to the IRS,[1] the first type is:
“(1) Basic automatic enrollment (Automatic Contribution Arrangement or ACA):
- Employees are automatically enrolled in the plan unless they elect otherwise
- Plan document specifies the percentage of wages that will be automatically deducted
- Employees can elect not to contribute or to contribute a different percentage of pay”
With this feature, participants are automatically enrolled at a pre-determined rate until they change or eliminate their contribution. Participants can change their deferral election before the first payroll or at any time after. However, under this ACA design, once the participant’s money is withheld, the money must stay in the plan until the participant has a distributable event. This can cause some challenges and increased administrative effort as the plan will have an increased number of accounts that will require the distribution of all notices and disclosures regardless of account balance size. And of course, notice must be supplied at least 30 days before the employee is eligible and annually thereafter. With immediate eligibility, notice must be provided prior to the first payroll for which the employee becomes eligible. Your recordkeeper should be able to draft and distribute this notice on your behalf, but it is worth checking as not all recordkeepers will do so.
It is worth pointing out that an ACA design may be implemented at any time during a plan year.
The second type is:
“(2) Eligible automatic contribution arrangement (EACA)[2]:
- Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice
- May allow employees to withdraw automatic contributions, including earnings, within 90 days of the date of the first automatic contribution”
With this feature, participants are automatically enrolled until they change their contribution and, if they elect not to participate they can get a full, penalty-free return of their contributions within 90 days of their first contribution. This return of contribution feature can ameliorate participants who were defaulted and provide comfort to the administrators knowing that participants can get their money back. Of course, you will need to provide the above mentioned initial and annual notices at least 30 days, but not more than 90 days, prior to enrollment and prior to the beginning of each plan year.[3]
Please note, an EACA plan design may only be implemented on the first day of a plan year.
The third type is:
“(3) Qualified automatic contribution arrangement (QACA)[4]:
- Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice
- Meets additional “safe harbor” provisions that exempt the plan from annual actual deferral percentage and actual contribution percentage nondiscrimination testing requirements
- Default deferral percentage starts at 3% and gradually increases to 6% with each year that an employee participates. The default percentage cannot exceed 10%.
- Required employer contributions. Pick either:
- matching contribution: 100% match for elective deferrals that do not exceed 1% of compensation, plus 50% match for elective deferrals between 1% and 6% of compensation; or
- nonelective contribution: 3% of compensation for all participants, including those who choose not to make any elective deferrals.
- Employees must be 100% vested in the employer’s matching or nonelective contributions after no more than 2 years of service
- Plan may not distribute any of the required employer contributions due to an employee’s financial hardship”
With this design, the employer must determine in advance if the QACA will be an EACA or just an ACA. That decision will determine if participants can get a return of their contributions within 90 days of their first contribution. And similar to the EACA, the QACA may only be implemented on the first day of the plan year and requires both the initial and annual notices.
It is worth noting that the automatic deferral rate must begin at a minimum of 3% and increase for those automatically enrolled by at least one percentage point each year, to at least 6%, but not to exceed 10%. Further, the QACA design exempts plans from annual actual deferral percentage (ADP) and actual contribution percentage (ACP) nondiscrimination testing requirements.
Automatic enrollment may not be for everyone, including governmental entities in states with anti-garnishment laws that prevent non-ERISA plans from using automatic enrollment. But where you can, I prefer the EACA design because of the 90-day refund window for participants who truly do not want to or can’t afford to participate. If after 90 days they have not taken any steps, well….
For further information on the content of the notices, see the IRS website describing the notice requirements.
Notes:
[1] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-automatic-enrollment
[2] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-automatic-enrollment
[3] https://www.irs.gov/retirement-plans/faqs-auto-enrollment-when-must-an-employer-provide-notice-of-the-retirement-plans-automatic-contribution-arrangement-to-an-employee
[4] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-automatic-enrollment
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