IRS Proposes Regulations Regarding Automatic Contribution Arrangements
PENSION BENEFITS
- Eighth Circuit Reinstates 401(k) Plan Fee Lawsuit Against Wal‑Mart
- IRS Issues 2009 Cumulative List
- Pension Plan Limitations for 2010
- IRS Issues Final Regulations under Code Section 436
- Recent IRS Guidance Addresses Contribution of Unused Paid Time Off, Automatic Enrollment and Tax Notices
- Supreme Court Holds that Pension Plan May Apply a Benefit Formula That Treats Pre-Pregnancy Disability Act Pregnancy Leave Less Favorably Than Other Medical Leave
- IRS Issues Guidance on Suspension of Safe Harbor Nonelective Contributions
- Treasury Department Issues Final Regulations on Automatic Enrollment Plans
- Kennedy v. DuPont: The Supreme Court Makes Life a Little Easier for Plan Administrators
- IRS Issues 2008 Cumulative List
- Pension Plan Limitations for 2009
- Heroes Earning Assistance and Relief Tax Act Adds Benefits for Those in Military Service
- Benefits Quiz
- Supreme Court Rules Defined Contribution Plan Participants Can Sue for Losses to Their Individual Accounts
- IRS Issues Guidance for New Distribution Requirements that Become Effective in 2008
- New Multiemployer Plan Disclosure Requirements — ERISA Section 101(k)
- IRS Issues 2007 Cumulative List
- Final Section 403(b) Regulations: What Plan Sponsors Need to Know
- Pension Plan Limitations for 2008
- IRS Issues Final Regulations Affecting Section 403(b) Plans Covering Employees of Tax-Exempt Organizations, Public Schools and Churches
- Treasury Department Issues Final Regulations under Code Section 415
- IRS Updates Procedures for Opinion, Advisory and Determination Letter Applications
- Contacting Missing Plan Participants — Practical Considerations
- 2007 Final Roth 401(k) Regulations: The Latest Chapter
- Public Safety Employees and the Pension Protection Act of 2006
- DOL Issues Interim Final Rule Relating to the Time and Order of Domestic Relations Orders
- Guidance Issued on Deduction of Contributions to Defined Benefit Plans
- IRS Issues Distribution Guidance in Notice 2007–7
- IRS Issues Transitional Guidance Regarding Divestiture Rights and A Model Notice
- New Notices and Disclosures for Plan Sponsors under the PPA
- Cash Balance Plans — A Clearer Future?
- Pension Plan Limitations for 2007
- IRS Finalizes Anti-Cutback
Regulations: Heinz and Utilization Test Included - Internal Revenue Service Updates and Expands the Employee Plans Compliance Resolution System
- The Internal Revenue Service Issues a Second Set of Final Regulations Regarding the Disclosure of Relative Values of Optional Forms of Benefit
- The Book on the Roth 401(k) and 403(b) and Why Your Business or Organization Must Have One (maybe)
- The Internal Revenue Service Releases 2005 Cumulative List of Changes
- Two Recent Court Decisions Remind Plans to Exercise Caution in Handling Contested Benefit Claims
- Pension Plan Limitations for 2006
- Relative Value Information Required to Be Included in Certain QJSA Explanations As Early As November 3, 2005
- Treasury Department Issues Proposed Section 415 Regulations
- IRS Issues Proposed Roth 401(k) Regulations
- Revenue Procedure 2005–23 — Internal Revenue Service Guidance for Implementing Heinz Decision
- Use of an Administrative Committee to Address Fiduciary Obligations of a Retirement Plan Sponsor
- 401(k) and 401(m): IRS Issues Final Regulations
- Proposed and Temporary Section 403(b) Regulations of Interest to Tax-Exempt Employers
- Missing Participants
- The American Jobs Creation Act of 2004: Employee Benefits Related Issues
- The Automatic Rollover of Mandatory Cash-Outs: The Department of Labor's Safe Harbor Final Regulations
- Pension Plan Limitations for 2005
- IRS Issues Final 401(a)(9) Minimum Distribution Regulations
- Unanimous Supreme Court Decision Determines That Post-Retirement Plan Amendment Violates ERISA's Anti-Cutback Rule
- PBGC Announces New Participant Notice Voluntary Correction Program
- DOL Addresses Modifications Made to Pre-Existing QDROs
- Revenue Procedure 2004–25 Extends Remedial Amendment Period Only for Certain Specified Disqualifying Provisions
- New Requirement for Automatic Rollovers of Small Cash-Outs from Qualified Plans: The Proposed Regulations
- IRS Issues Updated Procedures for Waiver of Minimum Funding Standards
- IRS Issues Guidance Clarifying Allocation of Plan Expenses to Inactive Participants
- New Legislation Clarifies Rule on Plan Loans to Servicemembers
- Proposed 401(k) Regulations Include Interesting ESOP Change
- Pension Plan Limitations for 2004
- Recent Court Cases on Cash Balance Plans
- Internal Revenue Service Simplifies and Streamlines the Employee Plans Compliance Resolution System
The Pension Protection Act of 2006 (the "PPA") added automatic contribution arrangements to the Internal Revenue Code (the "Code") for use in Code section 401(k), 457 and 403(b) plans. The Internal Revenue Service (the "IRS") recently issued proposed regulations regarding certain aspects of these automatic contribution arrangements. The proposed regulations are effective for plan years beginning on or after January 1, 2008, and plan sponsors may rely on them until final regulations are issued.
The two automatic contribution arrangements that the proposed regulations cover are "qualified automatic contribution arrangements" ("QACAs") and "eligible automatic contribution arrangements" ("EACAs"). This article will focus on the main issues addressed by the proposed regulations as they relate to QACAs and EACAs.
Qualified Automatic Contribution Arrangements
If a plan qualifies as a QACA, it will be considered a safe harbor plan, and will be exempt from certain non-discrimination (e.g., ADP and ACP) and top-heavy testing requirements to which it normally would be subject on an annual basis. In order to be a QACA, a plan must satisfy the automatic contributions, employer contributions, notice and plan year requirements.
Automatic Contributions Employees who were eligible to participate on the date the QACA was implemented, but made an affirmative election not to have elective contributions made on their behalf, may be a difficult category of excludable employees for plan sponsors to identify. It appears from the proposed regulations that in order for an employee to be in this category, he or she must have actually filed an election with the plan administrator indicating that he or she does not want to participate in the salary deferral portion of the plan. If the plan sponsor cannot determine whether a particular employee made such an affirmative election, the plan sponsor may want to automatically enroll the employee in order to avoid the possibility of the plan's loss of QACA status.
In addition to being automatically enrolled in the plan, an eligible employee must have a certain percentage of his or her eligible compensation deferred into the plan (unless and until he or she elects otherwise). A QACA must provide that — at a minimum — an employee will have default elective deferrals made on his or her behalf in accordance with the following schedule:
Year of Participation — Minimum Required Deferral Rate
Initial Period (defined below) — 3%
2nd Year — 4%
3rd Year — 5%
4th Year (and all following years) — 6%
The proposed regulations define the "Initial Period" as the period beginning on the date the employee first participates in the QACA and ending on the last day of the following plan year. For example, assuming the plan utilizes a calendar year plan year, the Initial Period of an employee who begins participating in the QACA on January 1, 2008 will end on December 31, 2009. As stated above, these percentages are minimums. A plan can provide that a greater percentage will be deferred. For example, a plan could provide that 4% of eligible compensation would be deferred on behalf of an eligible employee during the employee's Initial Period. The plan could also provide that the default deferral rate would remain at 4% until the end of the "2nd Year." The plan would have to provide, however, that the automatic deferral percentage would be at least 5% in the "3rd Year." Please note that the maximum percentage that can be automatically contributed on behalf of an eligible employee in a QACA is 10% of his or her eligible compensation. Of course, an eligible employee can affirmatively elect to have a greater percentage contributed on his or her behalf, subject to plan and Code limits.
The minimum required deferral rate set forth in the preceding table must be uniformly applied to all eligible employees who are automatically enrolled in the QACA, except as follows:
A QACA must provide that all employees who are eligible to participate in the plan will be automatically enrolled in the plan. The only exception provided in the proposed regulations applies to employees who were eligible to participate in the plan on the date the QACA was implemented and who had an affirmative election in effect (and that remains in effect) either to:
Employer Contributions The proposed regulations also state that the QACA may require eligible employees to have up to 2 years of service in order to become 100% vested in employer contributions. This is another advantage over the traditional safe harbor plan, in which employer contributions must be 100% vested at all times.
The proposed regulations also provide that in order to be a QACA a plan must provide that the employer will make either non-elective or matching contributions on behalf of non-highly compensated eligible employees as follows:
Notice In addition to providing the information required in a traditional safe harbor plan notice, the QACA notice must also include the following information regarding an eligible employee's rights and obligations under the QACA: The notice must be sufficiently accurate to inform the employee of his or her rights and obligations under the QACA, and be written in a manner calculated to be understood by the average employee to whom the QACA applies. On November 15, 2007, the IRS published a sample automatic contribution notice. Plan sponsors should review the sample notice (which can be found here) and revise it as necessary to ensure that it meets the needs of their plans. Please contact us if you would like assistance preparing this required notice.
The QACA notice can be combined with the plan's notice regarding the Qualified Default Investment Arrangement ("QDIA"), if applicable, and can be provided to eligible employees pursuant to the regulations permitting the use of electronic media to provide certain notices. However, it cannot be combined with other plan communications, such as the Summary Plan Description or a Summary of Material Modifications.
Under the proposed regulations, every eligible employee (not just those who are automatically enrolled in the QACA) must receive a notice regarding the QACA. This notice must be provided to the employee within a reasonable amount of time before he or she first becomes an eligible employee and prior to the beginning of each plan year thereafter. Under the proposed regulations, the "reasonable amount of time" requirement for the initial eligibility notice is deemed satisfied if the notice is provided no earlier than 90 days prior to the date the employee becomes an eligible employee and no later than the date on which he or she becomes an eligible employee (e.g., the first day of employment for immediate eligibility plans). The "reasonable amount of time" requirement for the annual notice is deemed satisfied if it is provided no more than 90 days and no less than 30 days prior to the beginning of each subsequent plan year.
Plan Year
Under the proposed regulations, the QACA must be in effect for the entire plan year in order to be a valid QACA. As a result, the QACA must be adopted (and the related notice must be distributed) prior to the beginning of the first plan year in which it is being implemented. However, under the PPA, the plan does not have to be amended until the end of the plan year that begins in 2009 as long as the plan is operated in accordance with all the rules related to the QACA during all relevant plan years prior to the adoption of such amendment.
Eligible Automatic Contribution Arrangement
An EACA must satisfy most of the rules under the proposed regulations that apply to the QACA. This section of the article will highlight some of the similarities as well as the differences between the QACA and the EACA.
Automatic Contributions Unlike the QACA, the EACA does not have to require either that a certain minimum percentage be deferred on behalf of eligible employees (e.g., 3% in the Initial Period under a QACA) or that the default annual percentage rate will be increased until such rate reaches 6%, and there is no maximum limitation on the percentage that can be automatically contributed. Therefore, a plan sponsor may elect to automatically enroll eligible employees at 2% (or, any other rate) without any annual increase in the percentage.
Finally, the same exceptions to the uniformity requirement for the QACA apply to the EACA. Specifically:
Like a QACA, the proposed regulations provide that an EACA must provide that all employees who are eligible to participate in the plan will be automatically enrolled in the plan. It is not clear, however, whether the proposed regulations also provide the narrow exception that applies to the QACA with regard to employees who were eligible to participate in the plan on the date the EACA was implemented (see discussion above). We are hopeful that the final regulations will clarify whether or not such employees must be automatically enrolled in the EACA.
Employer Contributions
Although the proposed regulations require that the plan sponsor of a QACA must make certain employer contributions to the plan on behalf of eligible employees (either a non-elective contribution or a matching contribution), the proposed regulations do not have any such requirement for plan sponsors of an EACA. The plan sponsor can decide what employer contributions, if any, it will make without the threat of losing the EACA status of the plan. In addition, any employer contributions made to the plan could be subject to the standard vesting schedule applicable to such employer contributions (e.g., a 6-year graded vesting schedule for matching contributions).
Notice It is not clear in the proposed regulations whether the notice must be provided to all eligible employees (regardless of whether they are subject to the automatic enrollment provisions of the EACA) or only to those eligible employees who are subject to the automatic enrollment provisions. We are hopeful that the final regulations will provide clarification regarding this issue. In the meantime, sponsors of EACAs may want to provide the notice to all eligible employees.
In general, the notice provisions discussed above (including, the timing, content and distribution rules) also apply to the EACA, with the following exceptions:
Plan Year
The proposed regulations are not clear with regard to whether the EACA must be in effect for an entire plan year in order to be a valid EACA. We are hopeful that the final regulations will clarify whether this requirement applies to the EACA, or only the QACA.
Qualified Default Investment Arrangement
Unlike the QACA, the EACA is required by the proposed regulations to invest default elective deferrals in a QDIA (to the extent the plan is subject to ERISA). In other words, until an eligible employee makes an affirmative investment election regarding his or her elective deferrals which were automatically contributed under the EACA, such contributions must be invested in a QDIA. Our article regarding the QDIA final regulations recently issued by the Department of Labor can be found in our November 2007 issue.
Non-Discrimination Testing A plan that is not an automatic contribution arrangement (and which is also not a safe harbor plan) must make such distributions within 2½ months after the relevant plan year. If the required distributions are not made within this timeframe, the distributions are subject to an excise tax. The proposed regulations provide that, for an EACA, these required distributions will not be subject to the excise tax so long as they are made within 6 months after the end of the relevant plan year.
In addition, the proposed regulations state that the distribution of excess contributions and/or excess aggregate contributions from any plan (whether or not it is an EACA) will: Caution: These changes are effective January 1, 2008 and will impact the distribution of excess contributions and/or excess aggregate contributions made in 2009 and subsequent years. Therefore, any distribution of excess contributions and/or excess aggregate contributions in 2008 which relate to the 2007 plan year are not eligible for treatment under the new rules set forth in this section of the article.
In contrast to the QACA, the EACA is subject to the non-discrimination and top-heavy testing rules. However, the EACA has special rules regarding the timeframe for distributing any excess contributions and/or excess aggregate contributions to participants when the plan fails the non-discrimination tests.
Permissible Withdrawals The amount of the withdrawal will be includible in the eligible employee's gross income for the taxable year in which the withdrawal is made. Any portion of the default elective deferrals being withdrawn which are Roth contributions will not be includible in the eligible employee's gross income when distributed. For example, a participant becomes eligible to participate in an EACA on November 1, 2008. Her employer makes non-Roth default elective deferrals on her behalf in November and December. In January 2009, she makes a request for a permissive withdrawal. The withdrawal will be includible in her taxable income for 2009 (not 2008) and will be reported on the Form 1099–R issued to her in January 2010. (The IRS has not yet issued the code that will be used to report this distribution on the Form 1099–R.)
Although the distribution is not subject to the 10% early withdrawal penalty tax or the mandatory federal and state withholding requirements, it may be reduced for any fees related to the withdrawal request. However, the plan cannot charge a fee for this type of distribution that is different than the fees it would charge for other types of distributions.
The proposed regulations provide that an EACA may, but is not required to, permit an eligible employee who has had default elective deferrals made on his or her behalf to elect to make a withdrawal (without spousal consent) of such default elective deferrals within 90 days after the date the first default elective deferral was made on his or her behalf. The employee is required to withdraw all default elective deferrals (adjusted for any gains or losses) made on his or her behalf, not just a portion of such deferrals. In addition, any matching contributions made with respect to the withdrawn default elective deferrals must be forfeited. Although the proposed regulations do not establish a timeframe for making the distribution and related forfeiture (if applicable), they should be made as soon as administratively feasible after the withdrawal request is made.
Other Automatic Contribution Arrangements There is one notable exception to the above exemption from the rules. Specifically, the PPA provides that if an automatic contribution arrangement provides notice to eligible employees regarding their rights and responsibilities under the arrangement, then ERISA will preempt state law with regard to the arrangement. Therefore, it a plan sponsor of an automatic contribution arrangement wants to benefit from the PPA's provisions for ERISA preemption of state law, it is required to provide a notice to eligible employees similar to the notice provided by the sponsor of a QACA or an EACA.
Finally, we want to point out that automatic contribution arrangements, including such arrangements in existence prior to January 1, 2008, that are not intended to be either a QACA or an EACA are not subject to most of the rules set forth in the proposed regulations. However, if such an arrangement is converted to a QACA or an EACA, then it would become subject to the proposed regulations from that point forward.
Conclusion
The proposed regulations provide much-needed guidance regarding QACAs and EACAs. However, not all issues have been addressed. We are hopeful that the IRS will provide further guidance and clarification of the rules related to these arrangements in the final regulations. Until then, plan sponsors may rely on the rules and guidelines set forth in the proposed regulations. Please feel free to contact us if you have any questions regarding the proposed regulations or the information in this article.
Copyright © Trucker Huss. All rights reserved. This article is published as an information source for our clients and colleagues. The article is current as of the date shown above, is general in nature and is not the substitute for legal advice or opinion in a particular case. In response to new IRS rules of practice, we inform you that any federal tax information contained in this writing cannot be used for the purpose of avoiding tax-related penalties or promoting, marketing or recommending to another party any tax-related matters in this writing.