<nobr>Nov 7, 2007</nobr>

Treasury, IRS Issue Proposed Rule on Automatic Enrollment

November 7, 2007 -- The Treasury Department and the Internal Revenue Service (IRS) today issued proposed regulations implementing new rules that facilitate the adoption of automatic contributions arrangements (ACA) in 401(k) plans and other similar plans under sections 403(b) and 457 of the Internal Revenue Code. The regulations, according to Treasury, are intended to provide answers for employers that will allow them to use these new automatic enrollment features next year. Employers may rely on these proposed rules pending the issuance of final regulations.

Comments on the proposed regulation are due by February 6, 2008. This memo represents our initial analysis based on our first reading of the proposed rule. We rely on feedback from you who have experience working with these plans to inform us of problems in the proposed rule's operation and application.

The regulations specify the requirements for meeting the statutory safe harbor for automatic contribution arrangements. To meet the safe harbor, plans must meet certain contribution and notice requirements included in the regulation. Plans that meet these requirements are referred to as qualified automatic contribution arrangements (QACA) and satisfies the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests for nondiscrimination.

Minimum Qualified Percentages

To meet the requirements of a QACA, a plan must:

• Adopt a plan provision implementing the ACA for an existing plan before the first day of the plan year and keep it in effect for an entire 12-month plan year;


• Provide that each non-highly compensated employee who is an eligible employee be generally permitted to make elective contributions in an amount that is at least sufficient to receive the maximum amount of matching contributions available under the plan year; and


• Provide that employee is permitted to elect any lesser amount of elective contributions.

The proposed regulation would implement a specified schedule of minimum automatic contributions for QACAs (qualified percentages). Plans may provide for higher qualified percentages than those specified in the schedule, except that the qualified percentage can at no time exceed 10 percent.

The schedule in the proposed rule is:

• From the date of the employee's first participation until the end of the following plan year (up to two years total): 3 percent.


• The next plan year: 4 percent.


• The next plan year: 5 percent.


• The next plan year and thereafter: 6 percent.

If a plan implements a higher qualified percentage in any period, it need not be increased in subsequent plan years so long as the qualified percentage is above the minimum level in the schedule. For example, a plan with an initial 4 percent qualified percentage could maintain that same contribution level in the first plan year of participation and for two subsequent plan years.

Application of Qualified Percentages

The proposed regulation would require that the qualified percentage be applied uniformly to all eligible employees, except that a plan is not disqualified as a QACA because:

• the percentage varies based on the number of years and eligible employee has participated in the the ACA intended to be a QACA;


• the rate of elective contributions in the plan that is in effect on the effective date of the default percentage under the QACA is not reduced;


• the amount of elective contributions is limited so as not to exceed the limits of 401(a)(17), 402(g) (with or without catchup contributions), or 415;


• or an employee is not automatically enrolled during the 6-month period following a hardship distributiong in which elective contributions are suspended.

The proposed regulation provides that the default election ceases to apply to any eligible employee if the employee makes and affirmative election that remains in effect to not have any elective contributions made on his or her behalf or specifies an amount or percentage elective contribution to be made. If an employee in the plan or a predecessor plan had an election in effect immediately before the effective date of the QACA they are excepted from the default election. According to the proposed rule, this would generally require that the employee completed an election form indicating an amount or percentage of his compensation to be deferred (including zero).

Matching and Nonelective Contribution Safe Harbor Requirements

Employers may elect to satisfy the matching contribution requirement or nonelective contribution safe harbor requirement. The level of employer nonelective contributions is the same as under section 401(k)(12), but the matching contribution requirement allows for a lower level of matching contributions. Specifically, a QACA using the matching contribution alternative need provide for matching contributions on behalf of the non-highly compensation employee equal to:

• 100 percent of the employee's elective contributions that do not exceed one percent of compensation; and


• 50 percent of the employee's elective contributions that exceed one percent but not six percent of compensation.

The proposed regulation also provides for a slower vesting schedule for matching and nonelective safe harbor contributions. QACA safe harbor contributions must be fully vested after two years of vesting service, rather than immediately. The same distribution restrictions that apply to safe harbor contributions under 401(k)(12) would also apply to QACA safe harbor contributions.

Notice Requirements

Each eligible employee under a QACA must receive a safe harbor notice within a reasonable period before each plan year. The notice must contain the information required under section 401(k)(12) and:

• the employee's right under the arrangement to elect not to have elective contributions made on the employee's behalf or to elect to have contributions made in a different amount or percentage of compensation; and


• how contributions made under the automatic contribution arrangement will be invested in the absence of any investment decision by the employee (including, in the case of an arrangement under which the employee may elect among two or more investment options, how contributions made under the automatic contribution arrangement will be invested in the absence of an investment election by the employee).

Under the QACA, the employee must be given a reasonable period of time after receipt of the notice and before the first elective contribution is to be made to make an election with respect to contributions and investments. The proposed regulations would provide that the general determination of whether the timing requirement is satisfied is based on all of the relevant facts and circumstances, and the deemed timing rule.

Under the deemed timing rule, the requirement is satisfied if notice is provided to each eligible employee:

• at least 30 days (and no more than 90 days) before the beginning of each plan year;


• within the 90 days preceeding the date on which the employee becomes eligible, if the employee becomes eligible after the 90th day of the plan year; or


• on the first day of employment, in the case of a plan with immediate eligibility when an employee is hired.

Permissible Withdrawals from an Eligible Automatic Contribution Arrangements

The proposed regulation would also implement new section 414(w) of the IRC creating eligible automatic contribution arrangements (EACA). Under the proposed regulation, an employer may elect to allow the withdrawal of automatic contributions (and attributable earnings) made with respect to the first payroll period to which the EACA applies to the employee and any succeeding payroll periods beginning before the employee requests the withdrawal.

The election to withdraw the contributions that were made under an EACA must be made within 90 days of the "first elective contribution with respect to the employee under the arrangement." The proposed regulations would define the arrangement for this purpose as the EACA so that the withdrawal option could apply to employees previously eligible under the plan, including one with an automatic contribution feature that was not an EACA. Because a plan can only include an EACA after the January 1, 2008 effective date, the withdrawal election can only apply to elective contributions after that date.

The 90-day window for making the withdrawal election begins on the date on which the compensation that is subject to the cash or deferred election would otherwise have been included in gross income. In addition, the proposed regulations would provide that the effective date of the election must be no later than the last day of the payroll period that begins after the date of the election.

The proposed regulations would provide that the distribution is generally the account balance attributable to the default elective contributions, adjusted for gains and losses. The distribution may be reduced by any generally applicable fees. However, the proposed regulations provide that the plan may not charge a different fee for this distribution than would apply to other distributions.

An employer who does offer this option is not required to make it available to all employees eligible under the EACA. Under a section 401(k) plan or a section 403(b) plan, however, the employer may not condition the right to take the withdrawal on the employee making an election to have no future elective contributions made on the employees behalf. Nonetheless, the employer could provide in the withdrawal election form a default election under which elective contributions would cease unless the employee makes an affirmative election.

The amount withdrawn under section 414(w) is includible in gross income in the year in which it is distributed, except amounts that are distributions of designated Roth contributions are not included in an employee's gross income a second time. The proposed regulations would require that this amount be reported on Form 1099-R and is not subject to the 10 percent penalty for early withdrawals. These withdrawals would not be eligible for a rollover.

In the event of a withdrawal election, any employer matching contribution with respect to the default elective contribution must be forfeited. The forfeited matching contribution cannot be returned to the employer (or be distributed to the employee as is permitted for an excess aggregate contribution). The proposed regulations would provide that the forfeited contribution must remain in the plan and be treated in the same manner under the plan terms as any other forfeiture under the plan.

Qualfied Percentages in an EACA

An EACA must provide that the default elective contribution is a uniform percentage of compensation. The proposed regulations would provide that the permitted differences in contribution rates provided in the proposed regulations for a QACA also apply to an EACA.

Default Investments in an EACA

Another requirement to qualify as an EACA is that automatic contributions are invested in accordance with the default investment regulations issued by the Department of Labor. ERIC issued a bulletin, on October 23, announcing the publication of these final regulations.

Notice Requirements in an EACA

The notice requirements and timing rules are generally the same for an EACA as the rule described above for a QACA.

Coordination of Notices

The proposed rule states that the IRS and DOL anticipate that a single document can satisfy all of the notice requirements (including those in 404(c)(5)(B) and 514(e)(3) of ERISA), so long as it has all of the requisite information for plan participants and satisfies the timing requirements for each of those notices.

Excess Contribution Distributions

The proposed regulations reflect the substitution of 6 months for 2 1/2 months as the time period in which excess contributions or excess aggregate contributions with respect to an EACA must be distributed to avoid the excise tax penalty. In addition, the proposed regulations reflect the elimination of the requirement that distributions of excess contributions or excess aggregate contributions (whether or not under an EACA) include attributable earnings for the period after the end of the plan year (gap period income).

The proposed regulations also reflect the change in the tax treatment of a distribution of excess contributions or excess aggregate contributions (whether or not under an EACA) under which the distribution of excess contributions or excess aggregate contributions (including earnings) is includible in the participant's gross income for the year of the distribution (without regard to the amount of the distribution). The proposed regulations would also amend the Income Tax Regulations to reflect these provisions in the correction rules for the ADP and ACP tests. All of these changes are proposed to be effective January 1, 2008 and will impact corrective distributions made in 2009.

In addition, the proposed regulations would also implement provisions of the PPA that made default elective contributions distributed under section 414(w) are not taken into account in the ADP test. They are also not permitted to be taken into account in the ACP test.

Effective Date

The proposed regulations would be effective for plan years beginning on or after January 1, 2008.

Member Action Requested

ERIC members are requested to send concerns, comments, and feedback about the proposed regulation to Mike Chittenden (mchittenden@eric.org) of the ERIC staff by November 30, 2007. ERIC plans to host a conference call in December to discuss the regulations and potential comments.

Proposed Regulations on Automatic Contribution Arrangements

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