Automatic Enrollment Update and QDIA Update
Rev. 12/20/07, E-mail Alert 2007-17

Click here for updated information based on the Automatic Enrollment Final Regs, which were issued February 24, 2009.

From the ACA to the QACA to the EACA, this article highlights some of the issues that have been raised in client calls.

QACA is a safe harbor 401(k) plan

The QACA is basically a traditional safe harbor 401(k) plan with an automatic enrollment provision and some new safe harbor features, courtesy of PPA. Thus, the traditional safe harbor 401(k) provisions (other than those changed for the QACA safe harbor) also apply to a QACA.

Thus, the new safe harbor match formula for a QACA ($/$ up to 1%, ½$/$ from 2% to 6%) is available or an enhanced match may be selected. The safe harbor contribution is also available as a flexible or guaranteed nonelective safe harbor contribution.

The QACA safe harbor must be added to the plan document (starting in 2009). For 2008 only a board resolution was needed, pursuant to PPA amendment guidelines. To add a QACA safe harbor to an existing 401(k) plan, the plan must be amended before the beginning of the plan year. Normally, a 12-month plan year is required. The traditional safe harbor exceptions to the 12-month plan year requirement apply to the QACA.

If stopping a safe harbor match midyear, the 30-day notice before stopping must be given and the plan must be tested.

There may be no allocation requirements for the safe harbor contribution, such as employment on the last day or being credited with a certain number of hours. Of course, the “otherwise excludible employee“ rules can be applied in determining who is eligible to receive the safe-harbor contribution. Vesting for a QACA is another new feature in that the plan may have 2-year cliff vesting on the QACA safe harbor contribution, while traditional safe-harbor arrangements have full and immediate vesting.

The QACA safe harbor contribution is provided to all employees who are eligible to defer, not just for those automatically enrolled.

QACA automatic enrollment escalator
The automatic enrollment escalator first year of participation rate is 3%. In addition, the first rate is to remain in effect from the day the participant is automatically enrolled until the end of the following plan year.

Example
A participant is hired February 11, 2009. The calendar year QACA plan has a one-month eligibility to defer and a monthly entry date. The employee satisfies eligibility on March 10, 2009and enters the plan on April 1, 2009. The employee is timely provided the automatic enrollment and QDIA notices and a salary deferral agreement. Since the employee does not respond, the employee is automatically enrolled on April 1, 2009 at a deferral rate of 3%. The 3% rate continues through the end of the following plan year, i.e. December 31, 2010. On January 1, 2011, the automatic enrollment escalator increases the deferral rate to 4% (on January 1, 2012 to 5% and on January 1, 2013 to 6%).

Keep in mind that since the QACA is first available in 2008, all participants who are automatically enrolled on January 1, 2008 would be at the 3% rate.

QACA Notices
Safe harbor Notice Requirement
Just as the traditional safe harbor 401(k) plan, the QACA must provide a safe harbor notice each year at a reasonable time before the beginning of the plan year. Generally, this means between 30 and 90 days before the beginning of the plan year. The notice requirement is folded into the old regulation timing. The participant needs to be provided with sufficient time to turn off or adjust the deferral amount.

Automatic Enrollment Notice
The IRS provided a model automatic enrollment notice and default investment notice. The notice must also be provided within a reasonable time before each plan year as well as when the participant is eligible to participate. The employee has the right to defer or not defer or defer at a different rate.

Is a QACA required to have a Qualified Default Investment Arrangement (QDIA)?
Though not legally required, QACAs with participant investment direction will most often have a QDIA. The QDIA provides employers a safe harbor from fiduciary risk when selecting an investment for a participant or beneficiary who fails to elect his or her own investment. The question being raised by industry practitioners, is why wouldn’t the QACA have a QDIA?

Coordinated Notices
PPA 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, permit a single notice (containing the requirements of all the notices) to be used, so long as it satisfies the timing requirements.

QACA Automatic Enrollment
Who do you have to automatically enroll?

• New participants that have not made an affirmative election to defer or opt out.
  
• Those participants defaulted without an affirmative election before the effective date of the QACA must be automatically enrolled.
  
• The plan can automatically enroll all eligible employees, but not reduce those participants who are presently deferring more than the QACA requires.
  

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 to defer some amount including “zero.” The affirmative election may be a permanent type that remains in effect and that authorizes either:

• that no elective contributions are to be made on the participant’s behalf, or
  
• 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:

• have the employer make elective contributions in a specified amount or percentage of compensation, or
  
• 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.

Qualified Percentage Uniform Application. The proposed regulations would provide that a plan does not fail this requirement merely because the percentage varies for the following reasons:

• The percentage varies based on the number of years an eligible employee has participated in the QACA;
  
• the rate of elective contributions under a participant’s CODA election that is in effect on the effective date of the default percentage under the QACA is not reduced; or
  
• the amount of elective contributions is limited so as not to exceed:
       the compensation cap [§401(a)(17)],
       the deferral limit [§402(g)] determined with or without catch-up contributions, or
       §415 limit.
  
• An employee who is suspended from making deferrals due to a hardship distribution may not be automatically enrolled during the six-month suspension period. 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.
  

What is an EACA?
An EACA is an eligible automatic contribution arrangement under 414(w) of the IRC. This section requires:

• 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 the appropriate notice.
  

90-Day Withdrawal Election Timeframe
An employer is permitted, but not required, to include the §414(w)(2) permissible 90-day revocation withdrawal provision in an applicable employer plan. If the employer opts to permit the 90 day withdrawal provision, the election to withdraw the contributions that were made under an EACA must be made within 90 days of the first deferral made for the employee under the arrangement. In other words deferrals made as of the first payroll date.

The proposed regulations define “arrangement” as an 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.

Other differences between EACA and QACA
The escalator of increasing deferrals is not necessary in an EACA. The EACA does not have to have a safe harbor although it may.

Is a QACA an EACA?
By definition a QACA is not an EACA. In reality, most plans will opt to have a QACA that is also an EACA by satisfying the EACA requirements. The QACA that is also an EACA will have the 90-day revoke and the QDIA.

What is an ACA?
An automatic contribution arrangement that existed prior to 2008 (or started in 2008) and that does not incorporate the QACA or EACA features. It would still require the automatic enrollment notice and may incorporate a safe harbor and/or a QDIA. Any plan with pooled investment management rather than participant direction will not qualify as an EACA.

QDIA Update

The DOL released the QDIA notice regulations October 24, 2007 with an effective date of December 24, 2007. The lack of a model notice and the short time span to digest and implement these regulations made it nearly impossible to get the notice out by November 24, to provide 30 days advance notice, of the effective date of December 24. Of course, the urgency was also to get the QDIA notice out by December 2, 2007, 30 days in advance of January 1, 2008 for the start of the QACA.

Keep in mind that the regulations provide the availability of a facts and circumstances method of satisfying the QDIA notice requirements. Perhaps that is helpful because of the issuance of the regulations so close to the deadline for providing the required notices that there was practically no human way possible for firms to get the QDIA notice out on time. Truly, this was because of the facts and circumstances.

ERISA Title 1 Fiduciary Responsibilities
Note that the QDIA does not provide relief from fiduciary responsibility in Title 1 of ERISA regarding:

• The employer is still responsible for selecting and monitoring the investments.
  
• The employer is responsible for prudence and diversification.
  
• The prohibited transaction rules still apply, e.g. party-in-interest rules, self-dealing rules.
  

QDIA Notice to All?
There is nothing in the regulation about who to give the notice to. Thus, the annual QDIA notice should be provided to all participants. This was viewed as the safest method for the employer.
Why everybody, even those who have made an investment election? Because a default investment may be needed at a variety of times and under a variety of circumstances, the employer will be better protected if the notice is provided as an annual blanket notice to all participants.

MHCO comment: Although this may be the most conservative choice, it may also be confusing for participants who are not subject to being in a QDIA. Thus, the notice must be carefully worded to explain that it applies only if the participant has not selected his or her investment options and thus has been defaulted into the QDIA investments as a result of not making a selection.

What are some events that give rise to the need for a default investment?

• If a participant enrolls and investment elections are not completed, or the employee does not respond timely, then the deferrals need to go into a QDIA until investment elections are clarified; i.e. incomplete enrollment or election form returned.
  
• Investment election form never returned.
  
• Profit sharing reallocation, and the individual is no longer a participant with an account balance.
  
• Reallocating forfeitures of employer matching contributions as nonelective for an eligible employee who never deferred and thus, never filled out an investment election.
  
• Switch of investment vendors and not all investments able to be mapped and the employee does not timely respond, thus a default is needed.
  

Is there a civil penalty for not timely providing the QDIA Notice?
Yes, there is a civil penalty for not providing the QDIA notice. We are awaiting DOL regulations to provide guidance as to what the penalty will be as there is nothing in the statute.

Avoid Selecting Investments with Short Term Fees.
Although investments with a churning fee was not addressed in the regulations, the fiduciary should look at fund characteristics for the QDIA and consider selecting a fund that does not have a churning-type fee since a distribution may occur within 90 days. The employer will still need to review the prospectus.

A rule of thumb is that if we allow a distributable event within 90 days of the contribution first being deposited, we should be protecting the principal of the investment from a lot of fees during that short time frame.

Why 120 days in the short term capital preservation investment, rather than 90?
This was designed to provide enough time to process revoked distribution requests received during the first 90 days. However, as of this point in time the IRS has not issued guidance as to when mistaken contributions must be distributed by the plan. In other words there is no 30-day requirement to make the distribution.

Bill Grossman, QPA