401(k) help

Final rules issued last week by the Internal Revenue Service will aid employers that want to add an automatic enrollment feature to their 401(k) plans without running non-discrimination tests.

However, the rules only apply to two types of automatic enrollment programs: qualified automatic contribution arrangements and eligible automatic contribution arrangements.

Under the rules, employers that meet the specific QACA design requirements are exempt from actual deferral percentage/actual contribution percentage non-discrimination testing. Those tests determine that contributions made by highly compensated employees don't, on average, exceed contributions by lower-paid employees by amounts set by law.

To qualify for the safe harbor from non-discrimination testing, the plan must begin the automatic contributions at 3% of salary, escalating up to 6% adding 1% a year, and provide a company match or non-elective contribution with two-year vesting.

The rules still require that employers offering QACAs automatically enroll all employees. However, employers that offer an EACA may choose to enroll select groups of employees, such as only those employees who are hired on or after a certain date or for non-union employees.

"You can have collectively bargained employees be exempt from automatic enrollment, or only require those employees to enroll and not the others," said Michael Weddell, a principal at Mercer LLC in Detroit. "Under the proposed regulations, this wasn't clear."

The final IRS regulations also extend the deadline for employers offering EACAs to make corrective distributions of excess contributions collected from employees who choose to opt out of the plan from March 15 to June 30. However, to qualify for this safe harbor, the EACA must enroll all eligible employees for the entire year.

EACAs allow employees who opt out of automatic enrollment to withdraw and cease their contributions within 90 days. However, they may not be entitled to collect a matching contribution. Employees are taxed on the distributions, but the distribution will not be subject to the 10% penalty tax that generally is imposed on withdrawals from 401(k) plans prior to age 59?.

Although employers had been anxiously awaiting the rules governing automatic enrollment in QACAs and EACAs since they were authorized under the Pension Protection Act of 2006, it is unlikely there will be a rush to introduce either of these types of programs, benefit consultants say.

Because of the economic downturn, employers are hesitant to introduce a plan design that would require a matching contribution or increase any existing contribution, according to Valerie Kupferschmidt, ERISA counsel at Hewitt Associates Inc. in Lincolnshire, Ill.

"The timing was not the best," agreed Sally Wheeler, a director at PricewaterhouseCoopers LLC in Washington. However, it could have been worse, she said. If the rules had been released earlier and employers implemented the new types of plans before the recession began, they'd be locked into making a matching contribution that they may no longer be able to afford, she said.

Fortunately, other types of automatic enrollment features can be added to 401(k) plans besides QACAs and EACAs, Ms. Kupferschmidt pointed out, noting that not all employers are interested in the special benefits available through either design.

She advised employers to conduct a cost-benefit analysis to determine which type of automatic enrollment feature is right for them.

Joanne Wojcik is senior editor at Business Insurance, a sister publication of Pensions & Investments