The primary benefit of an auto-enroll 401(k) plan is the potentially improved results of the ADP and ACP testing in a plan that does not include Safe Harbor provisions. Typically, the plan will automatically enroll employees once they are eligible based on the plan document provisions. An “Eligible Automatic Enrollment Arrangement (EACA)” does not require employer contributions.
As an alternative a “Qualified Automatic Contribution Arrangement (QACA)” can serve as an auto-enroll plan however employer contributions are required as either a matching contribution of 100% on the first 1% the employee defers and 50% match in excess of 1% up to 6%. The result of this option would provide an employee that defers 6% a match of 3.5%. In place of a matching contribution the employer can contribute 3% of compensation to all eligible employees regardless of whether or not they defer. The advantage of using the Safe Harbor auto-enroll is automatically satisfying the ADP/ACP test and top heavy requirements.
In both cases the plan sponsor must notify all employees who are eligible of the auto-enroll feature annually between 30 and 90 days prior to the beginning of each plan year allowing them to withdraw any contributions that have already been withheld from their salary or make an alternate election.
The auto-enroll percentage can be fixed or escalating. The most common start level is 3% and if escalating the 3% would increase by one percent each year based on the eligibility date of the employee. For example, if an employee became eligible in 2019 at 3% that would increase to 4% in the next year. An employee that became eligible in 2020 would begin with a 3% deferral. This approach can become challenging to properly monitor since there would be a different deferral percent for employees that become eligible in different years. Withholding an incorrect amount for any given employee in a year would be a fiduciary breach.
The notices to both EACA and QACA plans must include the default percentage rate and any escalation provision; the right and process to elect not to participate; how to choose a different deferral rate; how to make investment elections and how automatic deferrals will be invested in the absence of a voluntary investment election. This brings us to the provisions of the Qualified Default Investment Alternative (QDIA), i.e. how will deferrals be invested if the employee does not make an election.
A QDIA can be a life-cycle or target date fund; a balanced fund holding equities, bonds and cash or a professionally managed account. In most cases the balanced fund is not specific to the employee but more focused on economic conditions while the professionally managed account would reflect the employees’ specific needs, other investments, time line and risk profile, i.e. it is customized to each employee. Target date funds are also specific to each employee based on the target date closest to their retirement age, usually assumed to be 65. The target date fund becomes more conservative, i.e. less volatile, as the employee approaches the target date.
Stephen Abramson, CPC APS Pension Services Inc. firstname.lastname@example.org