Automatic Enrollment Rules from the Pension Protection Act of 2006
The Pension Protection Act’s (PPA) of 2006 contains automatic enrollment rules (found in Section 902 of the Act) that are applicable to plan years beginning on or after January 1, 2008. PPA provides several new incentives for sponsoring employers to adopt automatic enrollment in their 401(k) plans. Automatic enrollment allows an employer to enroll employees in a salary deferral plan without the employees’ affirmative election, as long as the employees have the right to “opt out” of contributing or change the amount of automatic deferral.

Automatic Enrollment Rules under PPA Automatically Apply to All Employees Eligible to Defer with Two Exceptions. The first exception is for those who are already deferring; the second exception is for those who have filed an election not to have deferrals. Any employee who is eligible to defer and who is not in one of these two categories is eligible to be automatically enrolled. The employer may choose to bring all eligible employees deferring under the minimum amounts under the program. MHCO Comment: We do not see the need to bring those who already completed and returned their election forms under the program.

State Withholding Laws Overridden. The new law eliminates conflicts with state laws, such as California, on wage withholding without employee consent, effective as of PPA’s enactment date. Accordingly, plan sponsors are no longer subject to challenges that automatic enrollment withholding is contrary to state wage and hours law. However, this preemption of state law is only available if an annual notice to the affected employees is provided before the start of each year. Plan administrators are giving participants an annual notice of their right to cease deferrals anyway, so this rule should be easy to follow.

Employee Notice Requirements Apply. The automatic enrollment procedure requires that the notice be provided to employees at three points in time: upon hire, just before eligibility requirements are satisfied and once a year. The notice must explain the employee’s right to decline automatic enrollment and to make changes to the election amount, including stopping deferrals.

Automatic Enrollment Safe Harbor Rules. The new law also contains safe-harbor rules that would relieve a “qualified automatic contribution arrangement” from nondiscrimination testing. Discrimination testing is forgone if the employer makes certain required contributions. The new required matching contributions are less than those required under preexisting 401(k) safe harbor matching contribution rules.

90-Day Revocation. All eligible automatic enrollment arrangements (whether meeting the requirements of the new “qualified" designation or not, including those offered by a 401(k) plan, 403(b) arrangement, or eligible 457(b) plan) can allow employees to take penalty-free withdrawals of automatic deferrals and related earnings if the withdrawal request is made within 90 days of the first deferral. This was designed for situations where an employee fails to return the enrollment form and subsequently complains when the employee sees how automatic enrollment affects take home pay. The deadline to request a revocation distribution is 90 days after the first payroll period in which automatic enrollment occurs.

Correction made on October 24, 2006. Note that we originally reported that the deadline for returning an "erroneous contribution" was April 15th after the year of deferral. This had been in the bill, but was not in the final Act. We await IRS guidance for what the actual deadline will be.

The IRS will be issuing additional guidance because the amount is being treated as an “erroneous contribution” and thus neither regular plan distribution rules nor testing would seem to apply. The amount is to be treated as taxable compensation.

Six-Month Period for Refund of Excess Contribution without 10% Penalty. “Non-safe harbor” automatic enrollment arrangements will have additional time to test for discrimination, and, if needed, make corrective distributions. The new deadline is six months after the end of the plan year, rather than 2½ months under pre-PPA law.

Relief from Fiduciary Liability Is Provided with Respect to Default Investments. PPA amends ERISA Section 404(c), which addresses fiduciary liability with respect to participant-directed plan investments. Essentially, the law provides that a participant who fails to exercise an investment election will be considered to have exercised control over a default investment if the participant receives a notice that explains his or her right under the plan to designate how contributions and earnings are invested and, in the absence of an investment election, describes the default investment into which those contributions and earnings will be invested. The notice must be provided within a reasonable period before the beginning of each plan year, and the participant must be given a reasonable amount of time to make an investment designation. Following this procedure will enable the plan fiduciaries to assert the protections of ERISA section 404(c). The U.S. Department of Labor (DOL) has been directed to issue regulations within 6 months of enactment to define these requirements. Based on DOL's track record, it will be interesting to see how long it takes.

Definition of a “Qualified Automatic Contribution Arrangement.” A qualified automatic contribution arrangement, first refernced above, is a new type of “safe harbor” that will allow a plan to avoid 401(k) nondiscrimination testing. A qualified arrangement must contain the following provisions.

• Minimum Deferral Percentage Each Year. A qualified arrangement will have an automatic contribution percentage of a minimum specified percentage that initially escalates each year. The minimum deferral in the first year is at least 3% but no more than 10%; in the second year the minimum increases to 4%; in the third year 5% and in the fourth year 6%.
• Automatic Enrollment Applies to All Employees Eligible to Defer; However It Does Not Have to Apply to Two Groups. Automatic enrollment does not have to apply to those who are already deferring; the second group is those who have filed an election not to have deferrals. Any employee who is eligible to defer and who is not in one of these two categories is eligible to be automatically enrolled.
• Minimum Employer Contribution Requirements. The plan sponsor is required to make either matching contributions at a rate of 100% of the first 1% of compensation deferred plus 50% of the next 5% deferred (for a maximum match of 3.5% of compensation) or nonelective contributions of at least 3% of compensation to all eligible non-highly compensated employees, whether the employees make deferrals or not.
• Pre-59½ Distribution Restrictions Would Apply.
• 100% Vesting With 2 Years of Service. Employer contributions must be 100% vested after an employee has completed no more than two years of service.
• Notice Requirement. Within a reasonable time before the beginning of the plan year, employees eligible to participate in the qualified arrangement must receive written notice of the employees’ rights and obligations, as spelled out in the law. As there is already a required notice to be given to any employee who is automatically enrolled, the PPA concept of the notice is not new.

Note: “GAP Period” earning distributions are eliminated for all plans not just automatic enrollment plans as of the end of 2008.

Also, earnings and corrective distributions are taxed in the year of distribution not contribution; even those made in the first 2 1/2 (or 6) months..

Treasury and the IRS are expected to release regulations clarifying the application of the new automatic enrollment rules.

Click here to check out our eSeminar "Automatic Enrollment: Is it appropriate for your clients?"

Click here to check out our eSeminar on the Pension Protection Act of 2006.

Click here for information on Newkirk's New Booklet: 2006 Pension Law Changes: What Every Employer Needs to Know