FAQ: Automatic Enrollment
Erik Daley, CFA
What is automatic enrollment?
With automatic enrollment, employees are automatically enrolled in the plan at a stated salary deferral percentage. While automatic enrollment is often accompanied by an employer contribution, the "automatic" aspect of employee enrollment is generally with regard to the deferrals of compensation that employees make to their accounts within the plan. Automatic enrollment is an optional plan provision that may be elected at the discretion of the plan sponsor. Also, employees are able to defer above or below the stated rate of deferral, including opting out of salary deferral participation entirely.
How does our employer-made contribution work with an automatic enrollment feature?
Plan sponsors have many options with regard to the design of the automatic enrollment feature. They can simply state an automatic enrollment percentage and make the stated employer contribution. They can also, however, integrate their employer-made contribution formula with the automatic enrollment feature to achieve "safe harbor" status and avoid any otherwise required compliance testing regarding that employer-made contribution. Examples of safe harbor automatic enrollment plan designs are below.
Automatic Enrollment Safe Harbor Matching Contribution
A typical safe harbor matching contribution formula when used with automatic enrollment is a match of 100 percent of the first 1 percent deferred plus 50 percent of the next 5 percent deferred. These employer-made matching contributions can be attributed to a 2 year cliff vesting schedule. The plan sponsor can calculate the match by payroll, quarter, or at year end.
Automatic Enrollment Safe Harbor Nonelective Contribution
With an automatic enrollment nonelective contribution, the plan sponsor makes a 3 percent of compensation nonelective contribution to all eligible employees without regard to the employees' salary deferrals to the plan. These monies can also be attributed to a 2 year cliff vesting schedule.
How is the initial salary deferral rate elected?
Plan sponsors may select the initial salary deferral rate based on many factors. Most simply, plan sponsors often analyze pre-automatic enrollment salary deferral rates, and determine the most comfortable rate from there. If, however, the plan sponsor wants to utilize the safe harbor designs described above, the starting automatic enrollment salary deferral rate must be between 3 - 10%. For plans with an automatic enrollment election of less than 6%, the plan sponsor must also include salary deferral increases of at least 1% annually until the participant's deferral rate reaches 6%. The stated percentages must be applied uniformly to all eligible employees.
Does my plan need a QDIA if we adopt an automatic enrollment feature?
Because employees are automatically enrolled, their deferrals (and any employer contributions) may start before they have had the opportunity to elect investment options. A plan electing a Qualified Default Investment Alternative (QDIA) will direct the employee's contributions to the QDIA in the event no other investment elections have been made. Adopting a QDIA helps insulate a plan sponsor from fiduciary liability with regard to the investment of these contributions.
Approved QDIA options are below:
- A product with a mix of investments that takes into account the individual's age, retirement date, or life expectancy (for example, a lifecycle or target date fund);
- A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (for example, a balanced fund);
- An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual's age or retirement date (for example, a professionally-managed account); and
- A capital preservation product for only the first 120 days of participation
If a participant is automatically enrolled and then decides not to participate, can they receive a distribution of the amounts deferred by virtue of tier automatic enrollment?
Yes, but only if the plan meets the requirements under IRS regulations for an "Eligible Automatic Contribution Arrangement." Under this type of automatic enrollment arrangement, a participant must request the distribution within 90 days of the date the first amounts were withheld from pay under the default deferral election. No partial distributions are allowed and any attributable match must be forfeited. The participant will receive a 1099.
Are current participants or employees impacted with the default deferral percentage?
All eligible participants can be made subject to an automatic contribution arrangement. The plan sponsor may decide, however, to automatically enroll only new employees prospectively, or automatically enroll both new employees and current employees who are not participating.
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