WASHINGTON The Internal Revenue Service proposed new regulations for defined contribution plan sponsors that want to offer automatic enrollment programs next year.
The proposed regulations, published in the Nov. 8 edition of the Federal Register, spell out the requirements that sponsors will have to meet to ensure their plans continue to qualify for special tax treatment. Comments on the proposed regulations are due by Feb. 6.
Automatic enrollment provisions included in the Pension Protection Act of 2006 apply to plan years beginning in January, so the IRS final regulations wont be available until after many plan sponsors are expected to launch the programs. But in its proposal, the IRS said that plans could rely on the proposed regulations for guidance pending issuance of the final rules.
If, and to the extent, the final regulations are more restrictive than the guidance in these proposed regulations, those provisions of the final regulations will be applied without retroactive effect, the IRS said, in its proposal.
The IRS proposed rules basically lay out the requirements for the two forms of automatic enrollment programs endorsed by the PPA: the qualified automatic contribution arrangement and the eligible automatic contribution arrangement.
One major advantage of the QACA is that it pre-empts the need for annual testing to ensure the plan doesnt discriminate between a companys higher-paid and lesser-paid employees. The QACA rules essentially say the contribution percentages of all employees must be the same. The minimum contribution is 3% of compensation, with increases by one percentage point annually up to 6% although a plan may provide for a contribution of up to 10%, under IRS the proposed regulations.
Under a QACA, an employer must make a contribution for all non-highly compensated employees, either as a discrete contribution or as a match to the employees contribution. A discrete employer contribution must equal at least 3% of an employees compensation. Matching contributions must equal 100% of the first 1% of an employees compensation and at least 50% of the contributions above 1% and below 6% of the employees compensation.
One potential drawback to the QACA approach is that the regulations require contribution increases to occur on a plan year basis. This will undermine the ability of employers to coordinate the timing of annual increases with annual raises, said the Groom Law Group, Washington, in a Nov. 26 memorandum for the firms clients.
Plans that opt instead to use the EACA approach would apparently be able to time automatic contribution increases with annual raises, according to the Groom Law Group memorandum. In addition, plans that use the EACA approach would have to ensure the default contribution rate was the same for all employees, apparently without a cap on the maximum or minimum contribution percentage, according to the Groom memorandum.
Plans using the EACA approach, however, would be required to do discrimination testing.
The other key advantage is that by using the EACA, a sponsor can return automatic enrollment contributions to an employee. Using the QACA approach, automatic enrollment contributions generally cant be returned to employee until retirement or termination of employment. But plans can use both EACA and QACA at the same time by meeting the regulations that apply to each arrangement.
Bill Sweetnam, a Groom Law Group partner, said that under the IRS proposed rules, many plan sponsors will opt for the QACA approach, in part to avoid the annual discrimination testing.
If you want to provide auto enrollment, this is the way you could do it and get around the non-discrimination rules testing, Mr. Sweetnam said.