The Pension Protection Act and Fiduciary Aspects of Automatic Enrollment in 401(k) Plans

The recently enacted Pension Protection Act of 2006 (the “PPA”) makes some of the most sweeping revisions to employee benefits law since the enactment of ERISA. Many provisions of the PPA have delayed effective dates, and we will be reporting on various aspects of the new law in upcoming issues of Benefits Report. The PPA makes a number of important changes to encourage the use by employers of “automatic enrollment” features in 401(k) plans, including provisions that are designed to facilitate compliance with the fiduciary duty rules of ERISA. Many of the provisions affecting automatic enrollment features are not effective until the plan year beginning after December 31, 2007, but one important provision of the PPA regarding ERISA preemption and automatic enrollment is effective now.

ERISA Preemption Applies for an “Automatic Contribution Arrangement”

The PPA addresses an open question as to whether ERISA preempts state laws that might impede or prohibit automatic enrollment features, such as laws requiring the written consent of an employee before any deductions may be made from his or her compensation. Many practitioners believe that automatic enrollment features are protected from state law by the general principles of ERISA preemption, and the U. S. Department of Labor (“DOL”) has issued advisory opinions to the same effect. The California Division of Labor Standards Enforcement (“DLSE”), however, has ruled that automatic enrollment arrangements (referred to in the opinion as “negative elections”) violate the California Labor Code which, in general, allows deductions from an employee’s wages only when expressly authorized in writing by the employee. The DLSE has also opined that the Labor Code requirements in this regard are not preempted by ERISA.

Section 902(f) of the PPA adds a new Section 514(e) to ERISA which explicitly provides that ERISA supersedes any state law which would directly or indirectly prohibit or restrict the inclusion of an “automatic contribution arrangement” in a plan. The DOL is given permissive authority to issue regulations setting minimum standards that an arrangement would be required to satisfy in order for this preemption rule to apply.

The PPA defines an “automatic contribution arrangement” as an arrangement under which:

  • a participant may elect to have the plan sponsor make payments as contributions under the plan on behalf of the participant, or to the participant directly in cash;
  • a participant is treated as having elected to have the plan sponsor make elective contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have elective contributions made (or specifically elects to have them made at a different percentage); and
  • elective contributions are invested in accordance with regulations issued by the DOL under ERISA Section 404(c)(5), which was added by the PPA, concerning default investments.

One near term problem with the new preemption rule is that the definition of an automatic contribution arrangement, which is effective now, requires compliance with regulations yet to be issued by the DOL pursuant to a separate provision of the PPA which revises ERISA Section 404(c) to provide protection from fiduciary liability from losses due to investment in properly selected default investments. The PPA directs the DOL to issue these regulations within six months of the date of enactment of the PPA, which was August 17, 2006, making mid-February 2007 the target date for the regulations. (The other provisions of the PPA regarding default investments are not applicable until plan years beginning after December 31, 2006.) Thus, the application of the new preemption provision is uncertain until the DOL issues the required default investment regulations.

Notice Requirement

New ERISA Section 514(e)(3) requires that the plan administrator of an automatic contribution arrangement provide participants with a notice of the participant’s rights and obligations under the arrangement within a reasonable period before the beginning of a plan year. The notice must be:

  • sufficiently accurate and comprehensive to apprise the participant of his or her rights and obligations; and
  • written in a manner calculated to be understood by the average participant.

Additional requirements for the notice include that it must:

  • provide an explanation of the participant’s right not to have elective contributions made on the participant’s behalf or to elect to have contributions made at a different percentage;
  • state that the participant has a reasonable period of time, after receipt of the notice and before the first contribution is made, to make an election regarding contributions; and
  • explain the default investment for the elective contributions.

Even prior to the passage of the PPA, some practitioners expressed concern that the PPA provision explicitly applying ERISA preemption to automatic contribution arrangements might actually result in a restriction of the application of ERISA preemption to such arrangements. This concern was based on the belief that general ERISA preemption principles already provide protection for automatic contribution features, whereas, under the PPA, preemption would be conditioned upon additional requirements, such as the need to provide notice to plan participants.

The PPA also amends ERISA Section 502(c)(4) to provide that the DOL may assess a civil penalty of not more than $1,000 a day for each violation of the notice requirement contained in new ERISA Section 514(e)(3), as described above. This new penalty provision regarding notices to participants in automatic contribution arrangements is, by the terms of the PPA, effective immediately. Again, the disjuncture between the immediate effective date of the PPA’s provision for ERISA preemption of state law concerning automatic contribution arrangements and the delayed date for the issuance by the DOL of the required default investment regulations presents possible difficulties in terms of compliance with the notice requirement and the avoidance of potential penalties for failure to comply with the new notice requirement. Presumably, the DOL will choose not to enforce the penalty provision of the new law concerning notice to participants in automatic contribution arrangements, at least with respect to the required explanation of default investments, until appropriate guidance has been issued.