A defined contribution industry group wants to remove a 10% cap on automatic escalation deferral rates for 401(k) plan participants.
The cap is contained in a provision of the Internal Revenue Code known as the qualified automatic contribution arrangement, and was mandated by the Pension Protection Act of 2006. It states that 401(k) plans' deferral rates cannot exceed 10% if the plan sponsor wants a safe harbor from discrimination testing.
Many retirement experts recommend employees contribute 10% to 15% for adequate income in retirement, according to testimony Feb. 3 by Lori Lucas, executive member of the Defined Contribution Institutional Investment Association and defined contribution practice leader at Callan Associates Inc., San Francisco. She spoke to the U.S. Senate Committee on Health, Education, Labor and Retirement in Washington.
A recent study showed that when combined with Social Security, beginning the deferral at 6% at the time of automatic enrollment (instead of 3% as it is now) and automatically raising that over time to 15% provides a majority of workers with 80% of their salary when they retire, Ms. Lucas said. The study was conducted by the Employee Benefit Research Institute, Washington, and the DCIIA.
“Inertia among participants keeps them from increasing above 6%,” Ms. Lucas said.
Lew Minsky, executive director of the DCIIA, who is based in Jupiter, Fla., said the QACA provision, published in 2007, included wording specifying that in order to avoid discrimination testing, plan sponsors cannot escalate deferral rates beyond the 10% threshold.
“What we'd like to see as an organization is plan sponsors starting to look at auto-feature programs with an eye toward the end result,” which is more money at retirement, Mr. Minsky said. “The right answer might be different for different plan sponsors,” he said.
Julie Stapel, Chicago-based ERISA attorney at Winston & Strawn LLC's employee benefits and executive compensation practice group, said the issue is one of perception. Many plan sponsors do not need to use the safe-harbor provision or seek safe harbor through other means, she said. But because the QACA rule sets a ceiling of 10% — which she says is “arbitrary” — many companies not even relying on the safe harbor are reluctant to exceed it. “It (the 10% ceiling) appears to have the government stamp of approval,” she said.
Ms. Stapel said the QACA rule sets the 10% cap to satisfy non-discrimination requirements that limit the extent to which highly compensated employees can contribute to 401(k) plans vs. how much non-highly compensated employees can contribute.
“Plan sponsors can either make sure their plans meet the numerical test or they can avail themselves of a so-called "safe harbor,'” she wrote in an e-mailed response to questions. “There is a 401(k) non-discrimination harbor predating the PPA that involves the plan sponsor making a certain minimum contribution to the 401(k) plan. In the PPA, to (promote) the use of automatic enrollment and escalation, a new non-discrimination safe harbor was added for automatic contribution arrangements that meet a number of technical requirements. One of those technical requirements is that the auto-escalation end at a 10% deferral rate.”
Ms. Stapel said she has not researched the issue of 401(k) plans losing their safe harbor for exceeding the 10% ceiling, but added she has never heard of it happening.
Josh Cohen, defined contribution practice leader at Russell Investments in Chicago, said in a telephone interview that many of his clients do not seek safe harbor through the QACA, but echoed Ms. Stapel, noting that they see it as a cue from the federal government.
He noted that a similar situation came about from a U.S. Treasury rule in 1998, specifying a 3% deferral rate at the time a participant is automatically enrolled. That rule is still in effect.