Background
On November 7, 2007, the IRS released proposed regulations for automatic contribution arrangements. The regulations may be relied upon pending the issuance of final regulations. If the final regulations are more restrictive, they will not be applied retroactively. Comments on the proposed rules are to be submitted to the IRS by February 6, 2008. 

PPA section 902 added 401(k)(13), 401(m)(12) and 414(w) to the code to facilitate automatic enrollment plans. These rules apply to 401(k) plans, 403(b) plans and 457(b) governmental plans. The effective date for these provisions is for plan years beginning after December 31, 2007.

An automatic contribution arrangement is a CODA that provides that, in the absence of an affirmative election by an eligible employee, a default election applies under which the employee is treated as having made an election to have a specified contribution made on his or her behalf under the plan.

90-day Revoke on Eligible Automatic Contribution Arrangement (EACA)
An EACA is permitted to allow employees to elect to receive a distribution equal to the amount of elective contributions (and attributable earnings) made with respect to the employee beginning with the first payroll period to which the eligible automatic contribution arrangement applies to the employee and ending with the effective date of the election. The election must be made within 90 days after the date of the first elective contribution with respect to the employee under the arrangement. The amount of the distribution is includible in gross income for the taxable year in which the distribution is made, but is not subject to the 10% early distribution tax under section 72(t) and is not eligible for rollover. The amount distributed is not to be included in the ADP test. For more details, see the entire 90-day revoke section under the EACA below.

Notice requirement of 414(w)(4)
Within a reasonable period before each plan year, each employee to whom the arrangement applies for such year is to receive a written notice of the employee’s rights and obligations under the arrangement. The notice is to be sufficiently accurate and comprehensive to apprise the employee of such rights and obligations.

The notice must explain:

• The employee’s rights under the arrangement to elect not to have elective contributions made on the employee’s behalf or to elect to have contributions made at a different percentage; and
• how contributions made under the automatic contribution arrangement will be invested in the absence of any investment decision by the employee.

In addition, the employee must be given a reasonable period of time after receipt of the notice and before the first elective contribution is made to make an election with respect to contributions. In many respects, the notice under section 414(w)(4) is the same as the notice required under section 401(k)(13) for a qualified automatic contribution arrangement.

The specific timing and content requirements for the QDIA notice [ERISA §404(c)(5)(B)] are generally the same as under IRC §414(w)(4), but the DOL has interpretative jurisdiction for that notice.

ERISA Preemption of State Law
The auto enrollment section of PPA (§902) also amended ERISA §514 to preempt any State law that would prohibit or restrict an automatic contribution arrangement. These regulations establish minimum standards that an auto enrollment arrangement must satisfy in order for this preemption to apply. The ERISA §514 definition of an automatic contribution arrangement is generally the same as the definition of an EACA IRC §414(w)(3), including the requirement that such automatic contributions be invested in accordance with the QDIA regulations.

ERISA §514(e)(3) requires a notice to be provided to each participant to whom the arrangement applies. The specific timing and content requirements are generally the same as the §414(w)(4) notice requirements, but the interpretative jurisdiction for that notice is also with the DOL.

NOTE: This is generally a re-writing of the explanation of provisions section of the proposed regulations with some comments.

Qualified Automatic Contribution Arrangement Under Section 401(k)(13)
The proposed regulations amend the final 1.401(k)-3 and 1.401(m)-3 regulations to add the QACA provisions. To the extent that the requirements to be a QACA are the same as those for the safe harbor 401(k), the proposed regulations apply the existing safe harbor 401(k) rules from the final regulations to a QACA. For example, the plan provision implementing the QACA for an existing qualified CODA would be required to be adopted before the first day of the plan year and remain in effect for an entire 12-month plan year. Similarly, a plan would be permitted to limit the amount of elective contributions, provided that each eligible NHCE generally is permitted to defer sufficiently to receive the maximum matching contributions available under the plan for the plan year, or elect any lesser amount of deferral.

QACA Escalator Rules
In order to be a QACA, the plan must provide a specified schedule of automatic contributions (called qualified percentages) for each eligible employee beginning with an initial minimum qualified percentage of 3% of compensation. McKay Hochman included this language in the final 401(k) and (m) regulation amendment added to the plan by the end of 2006.

The minimum qualified percentage begins when the employee first participates in the automatic contribution arrangement that is intended to be a QACA and ends on the last day of the following plan year. Thus, this initial period for a participant could last as long as two full plan years.

After this initial period, the minimum qualified percentage increases by 1% for each of the next three plan years. Thus, the plan year after the initial period is 4%; the qualified percentage increases to 5% for the next plan year, and then is 6% for all plan years thereafter. These are merely minimum qualified percentages.

QACA Rules Permit Higher Auto-Enrollment Percentages. A QACA can provide for higher percentages. For example, a QACA could provide for a qualified percentage in the initial period of 4% of compensation. If plan did so, it could also provide a 4% qualified percentage for the plan year after the initial period (the statutory minimum percentage for that plan year), 5% in the next plan year and 6% thereafter. However, the qualified percentage can at no time exceed 10% of compensation.

MHCO Comment: Therefore, the QACA could start at 6% in the initial year and stay at 6%. This avoids the administrative work involved with the escalator.

Qualified Percentage Uniform Application. §401(k)(13)(C)(iii) requires the qualified percentage to be applied uniformly to all eligible employees. The proposed regulations would provide that a plan does not fail this requirement merely because the percentage varies for the following reasons:

1. The percentage varies based on the number of years an eligible employee has participated in the automatic contribution arrangement intended to be a QACA;
2. the rate of elective contributions under a CODA election that is in effect on the effective date of the default percentage under the QACA is not reduced; or
3. the amount of elective contributions is limited so as not to exceed:
1. the compensation cap [§401(a)(17)],
2. the deferral limit [§402(g)] determined with or without catch-up contributions, or
3. §415 limit.
4. An employee who is suspended from making deferrals due to a hardship distribution may not make automatically enrollment deferrals, nor be automatically enrolled during the suspension. However, at the end of the suspension, the plan must resume the employee’s elective contributions at the level (percentage) that would apply if the suspension had not occurred.

Affirmative Election Supersedes Auto-Enrollment Deferral
§401(k)(13)(C)(ii) and the proposed regulations provide that the default auto-enrollment election ceases to apply if the employee makes an affirmative election, at which point the auto-enrollment is superseded. The affirmative election may be a permanent type that remains in effect and that authorizes either:

1. that no elective contributions are to be made on the participant’s behalf, or
2. that elective contributions be made in a specified amount or percentage of compensation.

Note that the election to stop auto-enrollment is not the same as the election to withdraw prior elective contributions within 90 days [under §414(w)].

Auto-Enrollment in QACA Superseded by Affirmative Elections in Affect Prior to the QACA
§401(k)(13)(C)(iv) and the proposed regulations provide a categorical exception from the QACA for employees who immediately prior to the effective date of the QACA, have an election in effect on that effective date. An election in effect means an affirmative election that remains in effect to:

1. have the employer make elective contributions in a specified amount or percentage of compensation, or 
2. not have the employer make elective contributions on his or her behalf.

Generally, this would require that the employee had completed an election form and chosen an amount or percentage (including zero) of his or her compensation to be deferred.

QACA Safe Harbor Contributions
As with the safe harbor in §401(k)(12), §401(k)(13) the employer has the choice of a matching contribution requirement or a nonelective contribution (NEC) requirement. However, while the QACA requires the same 3% (or more) NEC as a safe harbor 401(k) plan, the matching contribution requirement for a QACA allows for a lower level of matching contributions. Specifically, a matching contribution 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 on the first 6% deferred).

Vesting on QACA Safe Harbor Contribution
A QACA allows a slower schedule of vesting for both matching and NEC safe harbor contributions than the safe harbor in §401(k)(12). All QACA safe harbor contributions must be fully vested after 2 years of vesting service (within the meaning of section 411(a)), rather than immediately as required by §401(k)(12).

MHCO Comment: Thus, 2-year cliff vesting may be used, or 50% vesting in year one and 100% in year two, or a faster vesting schedule.

Withdrawal Restrictions
The same distribution restrictions that apply to safe harbor contributions and nonelective contributions under section 401(k)(12) apply to QACA safe harbor contributions.

QACA Safe Harbor Notice Requirement
Each eligible employee under a QACA must receive a safe harbor notice within a reasonable period before each plan year. The proposed regulations reflect the requirement that this notice must provide the information required under §401(k)(12). The regulations also reflect the additional timing and content requirements described in §401(k)(13)(E)(i).

Thus, the notice must also explain:

1. The employee’s right to elect not to have elective contributions made, or to elect to have contributions made in a different amount or percentage of compensation; and
2. how contributions made under the automatic contribution arrangement will be invested in the absence of any investment decision by the employee (including, in the case of an arrangement under which the employee may elect among two or more investment options, how contributions made under the automatic contribution arrangement will be invested in the absence of an investment election by the employee).
3. These additional requirements cannot be satisfied by reference to the plan’s summary plan description. Further, the proposed regulations would provide that in order to satisfy §401(k)(13)(E)(ii)(III), under the QACA, the employee must be given a reasonable period of time after receipt of the notice and before the first elective contribution is to be made to make an election with respect to contributions and investments.

Reasonable Period for Providing the Notice
The proposed regulations interpret the requirement under §401(k)(13)(E)(i) to provide a notice within a reasonable period before each plan year by applying the rules of §1.401(k)-3(d)(3).

Thus, the proposed regulations would provide that the general determination of whether the timing requirement is satisfied is based on all of the relevant facts and circumstances, and the deemed timing rule of §1.401(k)-3(d)(3)(ii) applies. 

Under this deemed timing rule, the timing requirement is satisfied if at least 30 days (and no more than 90 days) before the beginning of each plan year, the notice is given to each eligible employee for the plan year.

Notice Rules for New Plan and for New Employee
In the case of an employee who becomes eligible after the 90th day before the beginning of the plan year, the timing requirement is deemed to be satisfied if the notice is provided no more than 90 days before the employee becomes eligible (and no later than the date the employee becomes eligible). This would apply to all eligible employees for the first plan year under a newly established plan that provides for elective contributions, and to the first plan year in which an employee becomes eligible under an existing plan that provides for elective contributions. In the case of a plan with immediate eligibility when an employee is hired, this deemed timing rule would be satisfied if the employee is provided the notice on the first day of employment.

Eligible Automatic Contribution Arrangement Under Section 414(w)
To promote automatic enrollment, §414(w) provides limited relief from the CODA/retirement plan distribution restrictions for a 401(k), 403(b) or 457(b) eligible governmental plan with an EACA. Specifically, §414(w)(2) provides that, under an EACA, an employee can be permitted to elect to receive a distribution of the default elective contributions (and attributable earnings) made with respect to the first payroll period to which the EACA applies to the employee and any succeeding payroll periods beginning before the effective date of the election.

Section 414(w)(3) defines an EACA as an arrangement under which:

• a participant may elect to have the employer make payments as contributions under the plan on behalf of the participant, or to the participant directly in cash, 
• the participant is treated as having elected to have the employer make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or specifically elects to have such contributions made at a different percentage),
• in the absence of an investment election by the participant, such contributions are invested in a QDIA, and
• participants are provided a notice that satisfies the requirements of section 414(w)(4).

90-DAY REVOCATION RULES

90-Day Revocation Is An Optional Plan Provision
An employer is permitted, but not required, to include the §414(w)(2) permissible 90-day revocation withdrawal provision in an applicable employer plan.

Employer May Limit the 90-Day Revoke to Employees Who Never Deferred Before the EACA
An employer who does offer this option is not required to make it available to all employees eligible under the EACA. An employer might choose to make this available only to employees who never deferred before the EACA is effective. However, the employer may not condition the right to take the withdrawal on the employee making an election to have no future elective contributions because such a condition would violate the contingent benefit rule [§401(k)(4)(A) or the universal availability §403(b)(12)(A)(ii)]. However, the employer could provide — in the withdrawal election form — a default election under which elective contributions would cease unless the employee makes an affirmative election.

90-Day Withdrawal Election Timeframe
The election to withdraw the contributions that were made under an EACA must be made within 90 days of the ‘‘first elective contribution with respect to the employee under the arrangement.’’

The proposed regulations define “arrangement” as the EACA, so that the withdrawal option could apply to employees previously eligible under the CODA (including a CODA that is an automatic contribution arrangement but was not an EACA).

NOTE: An automatic contribution arrangement can only become an EACA on or after January 1, 2008 because §414(w) (creating the EACA) only applies to plan years beginning on or after January 1, 2008. Therefore, the 90-day revocation can only apply to elective contributions made after January 1, 2008.

Start of 90-Day Period
The 90-day window for making the withdrawal election begins on the date the deferred compensation would otherwise have been included in gross income. In addition, the effective date of the election must be no later than the last day of the payroll period that begins after the date of the election.

Distribution Calculation for 90-Day Period
The distribution is generally the default elective contributions, adjusted for gains and losses. The distribution may be reduced by any generally applicable fees. However, the plan may not charge a different fee for this distribution than would apply to other distributions.

If the default elective contributions are not maintained in a separate account, the amount of the allocable gains and losses will be determined using the GAP period income rules  for excess contributions [§1.401(k)–2(b)(2)(iv)].

Reporting Issues
The amount withdrawn is includible in gross income in the year in which it is distributed, except designated Roth contributions. The amount is to be reported on Form 1099–R. However, the amount is not subject to the additional income tax under section 72(t). Finally, §1.402(c)–2 is amended to include this transaction in the list of distributions that are not eligible for rollover.

Forfeit Any Match on a 90-Day Revoke Distribution
Any employer matching contribution with respect to the default elective contribution distributed pursuant to section 414(w) must be forfeited. The forfeited matching contribution is not a mistaken contribution or other erroneous contribution, and, thus, it cannot be returned to the employer (or be distributed to the employee as is permitted for an excess aggregate contribution). The forfeited contribution must remain in the plan and be treated in the same manner under the plan terms as any other forfeiture.

Escalator May Be Used by EACA
An EACA must provide that the default elective contribution is a uniform percentage of compensation. The permitted differences in contribution rates provided for a QACA also apply to an EACA.

QDIA Required for Title 1 Plans
An EACA’s automatic contributions are to be invested in accordance with DOL QDIA regulations [ERISA §404(c)(5)]. The proposed regulations would provide that this applies only if the plan is subject to Title I of ERISA. Thus, for example, this provision would not apply to a governmental plan (within the meaning of section 414(d)).

Notice Timing
The proposed regulations use the safe harbor 401(k) “reasonable period” timing requirements for the annual 414(w) notice requirement and for an employee who becomes eligible in a given year.

Coordinated Notices
PPA ’06 provides for several notices relating to automatic contribution arrangements that have similar content and timing requirements, such as the QDIA, auto-enrollment and safe harbor notices. The IRS, in coordination with DOL, anticipates that a single document can satisfy all of these notice requirements, so long as it has all of the requisite information for plan participants and satisfies the timing requirements for each of those notices.

Other Provisions of Section 902 of PPA ’06

The proposed regulations reflect the amendments to §4979 made by §902 of PPA ’06.

1. Regarding refund of excess or excess aggregate contributions
1. Time period of 6 months instead of 2½ months with respect to an EACA.
2. The elimination of the GAP period income for all plans.
3. Taxable in the participant’s gross income for the year of the distribution (without regard to the amount of the distribution) for all plans.

• The final regulations of 12-29-04 [§§ 1.401(k)–2 and 1.401(m)–2] are amended to reflect a, b and c above.

4. All of these changes are proposed to be effective January 1, 2008 and will impact corrective distributions made in 2009.

2. The final regulations of 12-29-04 are amended [§§ 1.401(k)–2 and 1.401(m)–2] to reflect that revocation distributions made within 90 days [§414(w)(6)] are not taken into account in the ADP test or the ACP test. 

1. The proposed regulations under section 401(m) have added a conforming change for other elective contributions that are not taken into account in the ADP test. The proposed regulations would also amend § 1.411(a)–4(b)(7) to reflect the amendment to section 11(a)(3)(G) made by PPA ’06 section 902(d)(2).

Effective Date
These regulations are proposed to be effective for plan years beginning on or after January 1, 2008. Taxpayers may rely on these proposed regulations for guidance pending the issuance of final regulations. If, and to the extent, the final regulations are more restrictive than the guidance in these proposed regulations, those provisions of the final regulations will be applied without retroactive effect.

Click here for information on our automatic enrollment eSeminar, that has been updated for these regulations.

Bill Grossman, QPA