3771 / What is an automatic enrollment safe harbor 401(k) plan?

The Pension Protection Act of 2006 created a new safe harbor plan under Section 401(k) called a “qualified automatic contribution arrangement,” available for plan years beginning after 2007.¹

Plans that provide for automatic enrollment and meet certain other requirements for the safe harbor will satisfy the ADP/ACP requirements ( Q 3753, Q 3802) and be excluded from the top heavy requirements ( Q 3916 to Q 3922). For this treatment to apply, a plan must satisfy an automatic deferral requirement, an employer contribution requirement, and a notice requirement.²

The automatic deferral requirement states that each employee eligible to participate in the plan must be treated as having elected to have the employer make elective contributions equal to a “qualified percentage.” The threshold amount of the automatic deferral percentage may not be less than 3 percent for the first year the employee’s deemed election applies. Employees may affirmatively elect out of the plan or elect a different deferral percentage. In the second year, this default percentage must increase to 4 percent, then 5 percent in the third year, and 6 percent in the fourth year and thereafter.³ A plan may provide for a higher percentage so long as it is applied uniformly, although the percentage may not exceed 15 percent. The SECURE Act increased the default percentage from 10 percent to 15 percent for tax years beginning after 2019 for any year after the first plan year when the employee’s compensation is automatically deferred into the plan.⁴ The contributions generally must continue until the last day of the plan year that begins after the date on which the first elective contribution under the automatic deferral requirement is made with respect to the employee.⁵

An employer also must provide either a matching or a nonselective contribution. The match amount must be 100 percent of the first 1 percent of compensation deferred, plus 50 percent of the amount of elective contributions over 1 percent but not exceeding 6 percent of compensation deferred. If an employer provides a nonselective contribution, it must be an amount equal to 3 percent of compensation for each employee eligible to participate in the arrangement.⁶ The plan may impose a two year vesting requirement with respect to employer contributions, but employees then must be 100 percent vested after two years.⁷

The written notice requirement is met if within a reasonable period before each plan year, each employee who is eligible to participate in the plan receives a written notice of his or her rights and obligations under the plan. The notice must be sufficiently accurate and comprehensive to apprise the employee of those rights and obligations, and it must be written in a manner that is calculated to be understood by the average employee to whom the plan applies. The notice must explain the employee’s right to elect not to have elective contributions made under the plan, or to have contributions made at a different percentage. If the plan allows the employee to choose from among two or more investment options, the notice must inform the employee how the account will be invested in the absence of any investment election. The employee also must have a reasonable period of time after receipt of the notice and before the first elective contribution to make one of the foregoing elections.⁸

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Planning Point: Further, under the SECURE Act, the notice requirements for safe harbor nonelective contributions of at least 3 percent of employer compensation has been eliminated (notice requirements for plans that provide only for an employer match remain in place).

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Relief Provisions

Effective August 17, 2006, ERISA preempts any state laws that would “directly or indirectly prohibit or restrict the inclusion in any plan of an automatic contribution arrangement.”⁹ This provision is designed to resolve the problem of state laws that treat automatic withholding by a 401(k) arrangement as a prohibited garnishment of wages. The DOL is authorized to issue regulations establishing minimum standards that an arrangement would have to satisfy to qualify for the application of this provision.¹⁰

For plan years beginning after 2007, relief from the 401(k) distribution restrictions ( Q 3797) and the 10 percent penalty ( Q 3969) is available during the first 90 days following the start of automatic deferrals, in the event that contributions are withheld erroneously. This relief applies not only to automatic enrollment safe harbor plans, but to other automatic enrollment plans that meet the definition of an “eligible automatic contribution arrangement.”¹¹

An eligible automatic contribution arrangement is a plan:

(1)  Under which a participant may elect to have the employer make payment as contributions under the plan on behalf of the participant, or to the participant directly in cash;

(2)  under which 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 elects a different percentage;

(3)  under which, in the absence of an investment election by the participant, the contributions are invested under the provisions of new ERISA Section 404(c)(5), in accordance with regulations described in Q 3772; and

(4)  that meets certain notice requirements.¹²

The timing and content of the notice requirement is virtually identical to that of the automatic enrollment safe harbor, set forth above.¹³

Refunds of excess contributions and excess aggregate contributions ( Q 3808) from eligible automatic contribution arrangements will be subject to an extended time deadline. Instead of 2½ months, the plans will have six months to make refunds of such distributions.¹⁴