New IRS Final Automatic Contribution Regulations: Key Changes

By Katie M. Rak, Richard L. Menson and Cheryl O'Donnell of McGuireWoods LLP Apr 2, 2009

On Feb. 24, 2009, the Internal Revenue Service (IRS) published its final automatic contribution regulations, with guidance on applying two major changes to 401(k) rules made by the Pension Protection Act (PPA): automatic contribution safe harbor requirements and the distribution of automatic contributions where a participant elects out of an automatic contribution program.

The PPA, passed at the end of 2006, codified the operation of automatic contribution arrangements in defined contribution plans, more commonly referred to as “automatic enrollment.” In late 2007, the IRS issued proposed regulations regarding these automatic contribution arrangements.

Many of the issues addressed in the proposed regulations are confirmed or clarified in the final regulations. Only minor changes have been made to the general provisions of the IRS guidance. However, there are a few key points that retirement plan sponsors should be aware of, as described below.

QACA: Automatic Contribution Requirements

Minimum contribution percentage. To maintain a Qualified Automatic Contribution Arrangement (QACA), plan sponsors are required to ensure that plan participants contribute the minimum contribution percentage amount for the initial plan year and each subsequent year until the participant either opts out of the QACA, elects a different contribution percentage or reaches a minimum contribution percentage of 10 percent. The final regulations clarify two aspects of this requirement:

  1. In determining the participant’s minimum contribution percentage, the initial plan year for each participant is the first year in which the participant has compensation taken out of such participant’s paycheck and deferred under the default arrangement. 

  2. Many commentators asked the IRS for clarification in determining the minimum contribution percentage for a rehired employee. The final regulations state that a rehired employee should generally be placed back into the plan at the minimum contribution percentage that would have applied if such employee had not left employment. However, if the employee had not been employed for more than one year, the final regulations make clear that plan sponsors are permitted to automatically enroll the rehired employee at a minimum contribution percentage as if he was a brand-new employee.

Election period length. Plan sponsors of QACAs are required to enroll automatically all eligible employees who do not have on file an affirmative election not to participate in the plan. Several commentators asked whether plan sponsors could set a limit on the length of an affirmative election, effectively giving each affirmative election an expiration date.

The final regulations permit plan sponsors to set an expiration date for all affirmative elections. The final regulations also allow a plan sponsor to, on the expiration date, automatically enroll in the plan all employees who did not make a second affirmative election, in effect allowing plan sponsors to re-enroll those employees every year. As an example, if a plan sponsor begins a QACA and automatically enrolls all participants as of Jan. 1, 2010, the sponsor can provide that all affirmative elections not to participate in the plan expire on Dec. 31, 2010. The plan sponsor can then re-enroll in the QACA all eligible employees who made an affirmative election for the 2010 plan year but neglected to make a second affirmative election for the 2011 plan year. Plan sponsors could do this every year.

Notice timing. Another condition for providing a QACA to plan participants is that proper notice must be given to each eligible employee within a reasonable period before the beginning of each plan year. In the case of new hires, the proposed regulations required that notice be given no less than 30 days prior to the date the first automatic contribution was made to the participant’s account. Many commentators expressed the impracticality of this provision in cases where new hires are immediately enrolled in the plan upon hire.

The final regulations provide that if the provision of a notice to new hires before they become eligible is impractical, notice can be given “as soon as practicable after” eligibility—as long as the employee is permitted to defer from all types of compensation that can be deferred from under the plan which the participant earns beginning on the participant’s hire date.

Newly adopted plans.The final regulations confirm that QACAs are required to be established for a complete plan year. However, several exceptions to this requirement exist. For example, the final regulations permit a newly adopted plan to establish a QACA midyear.

EACA: Opt-Out Distribution Requirements

The proposed regulations outlined the conditions for implementing an Eligible Automatic Contribution Arrangement (EACA) under a plan. An EACA generally allowed participants who were automatically enrolled in a plan to opt out of the plan and withdraw automatic contributions made on their behalf within a permissible withdrawal period of 90 days from the date of the first such contribution to the plan. This provision allows a window for those employees who fail to submit their paperwork to opt out prior to the first automatic contribution being made to recoup the amounts automatically deferred under the arrangement without incurring a penalty tax.

The final regulations allow plans to implement an EACA but allow plans to elect to shorten the permissible withdrawal period from 90 days to a period no shorter than 30 days. Also, the final regulations permit plan sponsors to charge those employees who elect to withdraw amounts during the permissible withdrawal period a fee not to exceed the same type of fee charged to participants who take other distributions under the plan.

Changes Affected by WRERA

The final regulations cite several provisions from the Workers, Retiree and Employer Recovery Act of 2008 (WRERA) that relate to the operation of automatic contribution arrangements. The most notable change that WRERA makes affects the requirements for an EACA. While the proposed regulations required that amounts contributed under an EACA (absent participant investment direction) be invested in a Qualified Default Investment Alternative, WRERA eliminated that requirement for EACAs.

Effective Dates

The provisions of the final regulations that cover QACAs are generally applicable retroactively beginning with plan years commencing on or after Jan. 1, 2008. The provisions of the final regulations that govern EACAs are generally applicable for plan years commencing on or after Jan. 1, 2010. However, plan sponsors are required to comply in good faith with the final regulations for the 2008 and 2009 plan years for EACAs.

Editor’s Note: This article should not be construed as legal advice.

Katie M. Rak is an associate at McGuireWoods and practices within the firm's taxation and employee benefits department. Richard L. Menson is a partner at the firm and handles matters related to executive compensation and employee benefits for publicly and privately held corporations, trusts, banks, insurance companies and various other entities. Cheryl O'Donnell Guth is also a partner, and has practiced in the areas of municipal finance, commercial real estate financing and employee benefits since 1985.

Republished with Permission. © 2009 McGuireWoods LLP. All Rights Reserved.


Additional Resources - External:

IRS Issues Final Regulations on Automatic Contribution Arrangements, McDermott Will & Emery, April 2009

IRS Finalizes Automatic Contribution Regulations, J.P. Morgan, March 2009

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