Automatic Enrollment May Offer Relief for Plan Sponsors
If you are a plan sponsor who wants to increase participation in your company’s 401(k) plan, but have shied away from a 401(k) Safe Harbor arrangement in the past, you may want to look into a new option for retirement plan design – automatic enrollment. A recent study conducted by PLANSPONSOR magazine revealed that 92% of employees would participate in a retirement plan if automatically enrolled. The concept of automatic enrollment in retirement plans has been gaining momentum recently, and thanks to the IRS, plan sponsors now have the option of implementing a Safe Harbor automatic enrollment method that can not only boost participation, but also eliminate the need for top heavy and discrimination testing.
Through the Pension Protection Act, the IRS created a new plan design known as the Qualified Automatic Contribution Arrangement (QACA). This new method, which can be applied to plan years beginning on or after January 1, 2008, was created to give plan sponsors the option to automatically enroll participants without the discrimination tests, top heavy rules and investment liabilities that have restrained implementation in the past. In fact, government offices and trade associations agree that QACAs could be the “right medicine” for the lack of personal savings among Americans.
The prime attraction of the QACA is the feature of automatic enrollment, also referred to as ”negative election”. Basically, eligible participants will be automatically enrolled in their company’s 401(k) plan regardless of whether or not they elect to join the plan. The automatic salary deferral must be invested in a “qualified default investment alternative” to ensure proper diversification. Further, participants must be provided with a notice that describes their right to revoke the election and how their contribution will be invested in the absence of their direction.
Another attractive feature of the QACA, as previously mentioned, is that it can also alleviate ADP/ACP and top heavy compliance testing requirements. This will allow highly compensated employees (who may have been limited due to failed testing in the past) to maximize their contributions.
The QACA also requires less stringent guidelines than required by the traditional 401(k) Safe Harbor that may be attractive to plan sponsors. The match for QACA has a lower requirement for employer contributions, which starts at 2% in year one and increases by 0.5% each year to 3.5% in year four (compared to 4% for the traditional Safe Harbor plan designs). Another appealing trait is a service requirement of two years for full vesting of employer contributions, in contrast to the traditional 401(k) Safe Harbor provisions that require 100% immediate vesting.
In a QACA, employees are automatically enrolled into default salary deferral rates that start at a minimum of 3% and increase by 1% each year for three years, stabilizing in year four at 6%. This will ensure that some of your fiduciary responsibilities as a plan sponsor are relieved, as the plan will help participants save more for retirement.
After weighing the advantages to your employees, the next step is to estimate the financial impact of implementing a QACA. If highly compensated employees in your plan are limited to what they can contribute due to failed testing, or if your participation in the 401(k) is low and the employees are averaging low deferral rates, a QACA may be a viable option to consider.
If you would like to discuss whether this plan would be a viable option for you and your employees, please contact our Retirement and Financial Services division at 919-913-0235. For further information, please visit the links below:
401(k) Automatic Enrollment - What You Need to Know
New QACA Option for 401(k) Enrollment Can Eliminate Discrimination and Top Heavy Testing
IRS Automatic Enrollment Notice
Automatic Enrollment Press Release
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May 23, 2008
Hill, Chesson & Woody strives to keep our clients' group decision makers abreast of trends influencing the employee benefits market. Look for Eyes on Benefits to bring you news and information affecting you and your employees.
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