401(k) Plans Automatic Enrollment & Safe Harbor after PPA Pam Thein Partner, Oppenheimer Wolff & Donnelly LLP Kim Wright - Vice President, Regional Director, Wachovia Retirement Services September 10, 2008 Background Employers shift retirement plans from defined benefit pension plans to 401(k) plans Research on 401(k) plan enrollment, savings behavior and automatic enrollment (Tab 1) 2008 Oppenheimer Wolff & Donnelly LLP The information contained in these materials is of a general nature and subject to change. Providing these materials is not intended to constitute legal advice in any particular matter and does not create an attorney client relationship. Readers should not act without further inquiry and/or consultation with legal counsel.
Pension Protection Act 2006 Congressional concerns about lack of retirement savings Employer concerns about automatic enrollment risks with state laws and default investments PPA added Eligible Automatic Contribution Arrangements ( EACA ) & Qualified Automatic Contribution Arrangements ( QACA ) - Code 401(k)(13) & 414(w) PPA added Qualified Default Investment Alternative ( QDIA ) fiduciary protection and specific preemption of state laws that impact or restrict automatic contribution arrangements - ERISA 404(c)(5) & 514(e)(1) 401(k) Plans Prior to PPA Automatic Enrollment IRS Guidance (e.g., Revenue Ruling 2000-8 & Information Letter to J. Mark Iwry, March 17, 2004) (Tab 2) Concerns employee dissatisfaction, whether ERISA preempts state laws Safe Harbor ADP, ACP & Top-Heavy Testing Automatic Enrollment (Pre-PPA)... IRS approved automatic enrollment and automatic increases in deferrals (e.g., IRS Revenue Ruling 2000-8 & IRS Information Letter to J. Mark Iwry, March 17, 2004) Automatic contributions deducted from pay until employee makes affirmative election not to defer or defer a different percentage No required deferral percentage (no minimum and no maximum)
Automatic Enrollment (Pre-PPA)... Initial and Annual Notice Required Initial - at the time employee is hired, employee receives a notice that explains automatic compensation reduction election, employee s right to elect to have no deferrals (or a different amount) deducted from pay, procedure for exercising that right and timing for implementation of any such election Annually - each participant is notified of his or her deferral percentage and the participant s right to change percentage, procedure for exercising that right and timing for implementation of any such election No rules on default investment Preemption not clear - some employers concerned about state wage laws requiring employee consent to deductions and minimum wage laws (although many thought these laws were preempted by ERISA) PPA Eligible Automatic Contribution Arrangements ( EACA ) PPA added Code 414(w) & ERISA 404(c)(5) IRS Proposed Regulations (November 8, 2007) (effective for plan years beginning on or after January 1, 2008 may rely on them now) (Tab 2) DOL Final Regulations (October 24, 2007) (Tab 3) DOL Field Assistance Bulletin 2008-3 & Correcting Amendments to Regulations (Tab 3) EACA... Requires - Automatic deferrals of uniform percentage of compensation until employee makes affirmative election to opt-out or defer a different percentage Default investment in Qualified Default Investment Alternative (QDIA) until participant makes an affirmative investment election Initial and Annual Notices
EACA... Initial and Annual Notices Timing Must give employees a reasonable period of time after receipt of notice and before automatic contributions begin to make affirmative deferral and investment election Initial Notice no more than 90 days before date employee becomes eligible for the plan and no later than date employee becomes eligible Annual Notice must be provided each plan year at least 30 days, but not more than 90 days, before first day of plan year EACA... Initial and Annual Notices - Content Specified percentage of automatic contributions if participant does not make affirmative election Participant s right to make affirmative election to defer nothing or defer a different (higher or lower) percentage How automatic contributions will be invested until participant makes an affirmative investment election If plan offers this feature - participant s right to make a 90-day withdrawal of automatic contributions and the procedure for making such withdrawal EACA... Optional 90-Day Withdrawal may allow employees to withdraw automatic contributions Employee must make election within 90-day period that begins on date first automatic contributions were deducted from paycheck Effective date of election cannot be later than last day of payroll period that begins after date election is made
EACA... Optional 90-Day Withdrawal... Amount of withdrawal is adjusted for earnings/losses and fees (if any general distribution fees under the plan cannot impose special fees for 90-day withdrawals) Matching contributions relating to withdrawn contributions are forfeited Withdrawal is includible in taxable income in the year of distribution (unless Roth contributions) EACA... ADP & ACP Testing Plan with EACA may make corrective distributions to HCEs up to six months after end of plan year (instead of 2½ months) to avoid excise tax EACA... Practical considerations of implementing EACA Financial impact on employer (higher matching contributions) Impact on plan (more small accounts) Optional 90-day withdrawal feature Timing Notices
ERISA Preemption PPA adds ERISA 514(e) Specifically preempts state laws that would otherwise prohibit or restrict an automatic contribution arrangement Must provide annual notice ADP/ACP Safe Harbors (pre-ppa) The Small Business Job Protection Act of 1996 added ADP and ACP safe harbors to Code 401(k) & 401(m) IRS issued guidance on safe harbors in IRS Notice 98-52, IRS Notice 2000-3 and final 401(k)/401(m) regulations issued in 2004 No need for ADP or ACP testing and safe harbor plan not top-heavy (ACP testing still required for after-tax contributions) Still available after PPA added QACA ADP/ACP Safe Harbors Requires - Minimum employer safe harbor contribution - matching ( basic or enhanced ) or nonelective 100% vesting of safe harbor contributions Distribution restrictions on safe harbor contributions Notice to participants
ADP/ACP Safe Harbors Vesting employer safe harbor contributions and earnings on those contributions must be 100% vested when made Distribution Restrictions employer safe harbor contributions must be subject to the same distribution requirements as elective deferrals, except that safe harbor contributions may not be available for hardship withdrawals ADP/ACP Safe Harbors Basic Matching Contribution Each NHCE must receive matching contributions equal to: 100% of elective deferrals made by NHCE up to 3% of employee s compensation and 50% of elective deferrals made by NHCE to the extent elective deferrals exceed 3% of NHCE s compensation, but not more than 5% of NHCE s compensation. ADP/ACP Safe Harbors Enhanced Matching Contribution Aggregate matching contributions equal or exceed matching contributions that would be made under basic matching contribution formula and rate of matching contributions does not increase as employee s rate of elective deferrals increases (e.g., matching contributions equal 100% of elective deferrals up to 4% of compensation) In no case may rate of matching contributions received by any HCE exceed rate received by any NHCE with same rate of elective deferrals
ADP/ACP Safe Harbors Non-elective Contributions Employer makes a non-elective contribution on behalf of each eligible NHCE that equals at least 3% of compensation May not be based on integration with Social Security ADP/ACP Safe Harbors Notices Annual & New Hires Each employee who is eligible to participate in the plan must receive a written notice - that satisfies certain requirements - at least 30 days (and no more than 90 days) before the first day of plan year in which plan is intended to satisfy safe harbor requirements During the year - must provide notice to each newly eligible employee ADP/ACP Safe Harbors Content of Notices must describe - Safe harbor nonelective or matching contribution formula Any other contributions under the plan and conditions for receiving such contributions The plan to which safe harbor contributions will be made (if different from the 401(k) plan) Type and amount of compensation employee may defer under the plan Procedure to make deferral elections (and administrative rules) Periods during which deferral elections may be made Vesting and distribution provisions How employees may obtain additional information (e.g., telephone numbers, address and e-mail address of individuals or offices that have the information)
ADP/ACP Safe Harbors Additional Requirements Plan s definition of compensation must satisfy Treas. Reg. 1.414(s)-1(d)(2) No year-end employment/1000 hour requirements to receive employer safe harbor contributions (but plan may have an initial eligibility service requirement to participate in the plan) ADP/ACP Safe Harbors Timing of Contributions matching or non-elective safe harbor contributions must be made within 12 months after end of plan year (timing may actually be earlier to satisfy deduction or other rules) Special timing rule if safe harbor matching contributions are made each payroll period and are not trued-up at yearend, matching contributions for each payroll period in a plan-year quarter must be deposited in plan s trust no later than last day of following plan-year quarter Matching Catch-Up Contributions - must match NHCEs catch-up contributions to extent required for NHCEs to receive full safe harbor matching contribution ADP/ACP Safe Harbors ACP Safe Harbor - If Basic Matching Contributions ADP Safe Harbor is used, this will also satisfy the ACP safe harbor if no other matching contributions are made under the plan If Enhanced Matching Contributions ADP Safe Harbor is used, this will also satisfy the ACP test if matching contributions do no exceed 6% of compensation and no other matching contributions are made under the plan If Non-elective 3% Contribution ADP Safe Harbor is used, this will also satisfy the ACP test if matching contributions are only made on elective deferrals & after-tax contributions that do not in the aggregate exceed 6% of compensation and rate of matching contributions does not increase as rate of elective deferrals or after-tax contributions increases. Employer may make discretionary matching contributions provided they do not exceed a dollar amount equal to 4% of employee s compensation
ADP/ACP Safe Harbors Effective Date/Plan Amendment - plan must be in effect for entire 12-month plan year (subject to a special rules if employer is acquired) and plan must be amended to reflect safe harbor contribution formula (for a plan using a safe harbor matching contribution formula, amendment must be adopted prior to first day of plan year) PPA Qualified Automatic Contribution Arrangements ( QACA ) PPA adds Code 401(k)(13) IRS Proposed Regulations (November 8, 2007) (may rely on them now) If plan satisfies QACA rules it is a safe harbor plan and automatically passes ADP and ACP testing Top-Heavy Testing QACA... In addition to pre-ppa ADP Safe Harbor rules, QACA requires: Automatic contributions by eligible employees Automatic increases in employee automatic contributions QACA also revises these pre-ppa ADP Safe Harbor requirements - Lower required employer matching contribution formula May impose vesting schedule no more than two years Initial & Annual Notices
QACA... QACA - Employee s Automatic Contributions QACA requires automatic 401(k) contributions for all eligible employees (until they make affirmative election not to participate or defer another amount) Exception for current employees who were eligible for plan prior to QACA effective date and who had made an affirmative election (even if 0%) QACA... QACA Percentage - must be uniform for all eligible employees but percentage may vary based on number of years an employee has participated in QACA contribution may be limited to comply with Code restrictions (e.g., 402(g) 401(a)(17) and 415 limits) deferral percentage may be a higher rate in effect immediately prior to QACA effective date QACA is reduced for six months after hardship distribution (and then resumes after the end of this suspension period) QACA... QACA Percentage - Amount Initial period (from employee s first day of participation in QACA until last day of following plan year (so could be up to two years) QACA percentage must be at least 3% Following plan years - QACA percentage must be at least 4% in plan year following initial period, then at least 5% in next plan year and at least 6% in next plan year Maximum QACA percentage in any year 10%
QACA... Required Employer Contribution Minimum 3% employer nonelective contribution OR Minimum Matching Contributions of 100% of 401(k) Contributions up to 1% of eligible earnings plus 50% of 401(k) Contributions between 1% and 6% of eligible earnings QACA... Distribution restrictions same as Traditional Safe Harbor Contributions (e.g., no in-service withdrawals before age 59½, no hardship withdrawals) Vesting may have two-year vesting schedule QACA... Notices Timing Initial Notice must be provided no earlier than 90 days before first eligible and no later than date first eligible Annual Notice must be provided each plan year at least 30 days, but not more than 90 days, before first day of plan year
QACA... Content of Notices Same as Traditional Safe Harbor Plan Notices plus, must explain - Employee s right to opt-out of QACA automatic 401(k) contributions How QACA employee and employer contributions will be invested until employee makes an affirmative investment election QACA... EACA optional QACA may (not required) also be an EACA If an EACA, the QACA may Allow for initial 90-day withdrawal of QACAs (if allowed, should also be in Initial and Annual Notices) Rely on extended six-month correction period for ACP testing (if QACA does not satisfy ACP safe harbor) QACA... Practical considerations of implementing QACA Financial impact on employer (safe harbor matching or non-elective contributions) Would Traditional Safe Harbor satisfy employer objective (at lower costs)? Combine with EACA? If so, add 90-day withdrawal feature? Timing Notices
Qualified Investment Default Alternative ( QDIA ) ERISA 404(c)(5) DOL Final Regulations (October 24, 2007) effective December 24, 2007 DOL Field Assistance Bulletin 2008-3 & Correcting Amendments to Regulations Compliance currently required for EACA (not QACA, unless also an EACA) QDIA... If QDIA then participant is treated as exercising control over his or her plan assets Plan fiduciaries not responsible for losses due to QDIA investment Plan fiduciaries are still potentially liable for prudent selection and monitoring of plan s QDIA QDIA... General QDIA requirements Plan Fiduciary must Decide how the QDIA product or portfolio will be managed Select a QDIA from one of three allowed types of investment Satisfy QDIA Notice Requirements
QDIA... Decide how the QDIA product or portfolio will be managed Investment manager or Plan trustee Plan s named fiduciary - plan sponsor, plan committee Registered investment company Investment fund or product that satisfies certain requirements QDIA... Select QDIA from one of allowed types of investment, which may include - Lifecycle or targeted retirement date fund changing mix of equity and fixed income assets based on participant s age, target retirement date (or life expectancy) Balanced fund - mix of equity and fixed income assets with risk level appropriate for plan s participants as a group Professionally managed account that uses a mix of assets based on participant s age, target retirement date (or life expectancy) a lifecycle or targeted retirement date approach QDIA... EACA Exception - may use capital preservation product (e.g., money market or stable value fund) as a QDIA for assets contributed pursuant to an EACA for up to 120 days after participant s first automatic contributions are made (DOL intent is to allow for 90day withdrawals) Product must be - * Offered by a state or federally regulated financial institution * Designed to preserve principal and provide reasonable rate of return (consistent with liquidity) Neither principal nor rate of return must be guaranteed At end of 120 days must transfer to one of three allowed QDIA products
QDIA... QDIA Notice Requirements Initial Notice - At least 30 days before date of plan eligibility or first QDIA investment * If EACA has 90-day withdrawal provision, initial notice may be provided on or before date of plan eligibility Annual Notice - At least 30 days before first day of plan year QDIA... Content of QDIA Notice * When (and how) assets will be invested in QDIA * Default QDIA and its investment objective, risk and return characteristics, fees and expenses * If applicable, when elective deferrals will be made on the participant s behalf, the automatic deferral percentage and the participant s right to optout (or elect a different percentage) * Rights of participants (and beneficiaries) to affirmatively direct investment of individual plan account assets * Participant s right to affirmatively direct investment of his or her plan assets * Participant s right to move assets to other plan investment alternatives (including restrictions, fees or expenses in connection with moving the assets) * How to obtain information about plan s other investments Combined Notice EACA, QACA and PPA ERISA Preemption all require Notices Single Notice may be used if it contains all necessary information and complies with timing rules IRS Sample Notice may be used for EACA and/or QACA (Tab 3) Sample notice is for hypothetical QACA that permits EACA withdrawals and has certain other characteristics. Must modify sample notice to the extent a plan s form and operations differ from the hypothetical plan. DOL has indicated this single notice may also be used to satisfy DOL s QDIA and ERISA preemption notice rules IRS website http:/www.irs.gov/pub/irs-tege/se111507.pdf
Employer Hypothetical Able Axles Co. Low participation by NHCEs Goal increase employee retirement savings with limited cost to employer Best Boots, Inc. Low participation by NHCEs Goal pass ADP/ACP at lowest employer cost Crazy Cars LLC High participation by NHCEs Goal pass ADP/ACP testing plus increase employee retirement savings
Comparison of Traditional ADP/ACP Safe Harbor & Qualified Automatic Contribution Arrangement ( QACA ) Traditional Safe Harbor QACA ADP/ACP Testing Not required [Same] Top-Heavy Rules Required Employer Safe Harbor Contribution Not apply (if only elective deferrals and safe harbor contributions made) Non-Elective 3% of compensation Basic Match 100% of 401(k) up to 3% of compensation plus 50% of 401(k) between 3% and 5% of compensation [4% match on 5% compensation] Enhanced Match A formula that equals or exceeds the basic match (e.g., 100% of 401(k) up to 4% of compensation Not apply [Same] 100% of 401(k) up to 1% of compensation plus 50% of 401(k) between 1% and 6% of compensation [3.5% match on 6% compensation] IRS proposed regulations do not give an example of an enhanced match formula. It might be possible to interpret equal to language in QACA regs to allow for an enhanced formula that equals or exceeds the QACA minimum match formula (e.g., 100% of 401(k) up to 3.5% of compensation) Vesting 100% May have Vesting Schedule 100% after 2 years Required automatic employee 401(k) contributions & automatic increases (QACA) No Yes
Traditional Safe Harbor QACA Safe Harbor Notice Required Required, plus must include information on QACA Qualified Default Investment Alternative ( QDIA ) Notice No year-end employment or 1,000 hours of service requirements to receive safe harbor contribution Distribution restrictions on safe harbor contributions same as distribution restrictions on 401(k) except safe harbor contributions may not be subject to hardship withdrawal Not required (unless plan has EACA or plan elects to comply with QDIA) Required Required Not required (unless plan is also EACA or plan elects to comply with QDIA) [Same] [Same] 2008 Oppenheimer Wolff & Donnelly LLP This information is of a general nature and subject to change. Providing this chart is not intended to constitute legal advice in any particular matter and does not create an attorney client relationship. Readers should not act without further inquiry and/or consultation with legal counsel
Comparison of Pre-PPA Automatic Contributions, Eligible Automatic Contribution Arrangement ( EACA ) & Qualified Automatic Contribution Arrangement ( QACA ) Pre-PPA Automatic Contributions EACA QACA Minimum automatic deferral percentage Maximum automatic deferral percentage Automatic deferral increases 90-day withdrawal of automatic contributions 6-month ADP corrective distribution period Required employer contribution ERISA preempts conflicting state laws None None Yes 3% (initial period) None None Yes - 10% Not required Not required Yes 3% - initial period (from 1 st day employee participates in QACA to last day of following plan year) 4% - next plan year 5% - next plan year 6% - next plan year No Yes (optional) No (unless plan is also EACA) No Yes No (unless plan is also EACA) Not required Not required Yes (match or non-elective) Yes Yes Yes QDIA rules required No (but may elect to follow) Yes No (unless plan is also EACA or elects to follow QDIA) Amend Plan Yes Yes Yes Annual Notice Yes Yes Yes 2008 Oppenheimer Wolff & Donnelly LLP This information is of a general nature and subject to change. Providing this chart is not intended to constitute legal advice in any particular matter and does not create an attorney client relationship. Readers should not act without further inquiry and/or consultation with legal counsel