By G. Alexander Hamilton
Memo to 401(k) Plan Sponsors –
Do you hate dealing with the ADP/ACP nondiscrimination tests each year?
Does your plan have trouble passing the tests?
Does the automatic enrollment/deferral feature that the government encourages interest you?
If the answer to any of these questions is “yes,” you may want to consider modifying your plan to make it a “Qualified Automatic Contribution Arrangement” or “QACA.” The QACA rules were enacted as part of the Pension Protection Act of 2006 (PPA) and are effective beginning in 2008. Final regulations were adopted in 2009. The QACA combines automatic enrollment/deferrals with certain minimum employer contributions — either across the board contributions or matching contributions — such that the annual ADP/ACP nondiscrimination rules are automatically satisfied and no testing is necessary. This is one of two “safe-harbor” design options that are available for 401(k) plan sponsors who want to avoid the annual ADP/ACP testing requirements.
According to a recent AON Hewitt survey of defined contribution plan sponsors—
More than half of the employers surveyed automatically enroll their participants in their 401(k) plan.
33% of employers surveyed use a safe harbor design to avoid ADP/ACP testing — 22% of those employers use a QACA, another 11% use the safe harbor provisions that existed before PPA (see 2011 Trends & Experience in Defined Contribution Plans published by AON Hewitt).
A brief overview of the QACA rules are set forth below.
Qualified Automatic Contribution Arrangement (QACA) A QACA requires minimum automatic deferral amounts which increase with each year the employee has an automatic contribution made and requires either a minimum match rate or an “across-the-board” non-elective employer contribution for all eligible employees of at least 3% of pay. While the automatic employee contributions are not required for any employee who has an affirmative election in place (even a zero), the employer contributions (either the match or the across-the-board contribution) must be made for all eligible employees, even those who have made an affirmative election.
Minimum Rate for Employee and Employer Deferrals/Contributions. The minimum contribution rate starts at 3% and begins when the employee first has automatic contributions made under a QACA. It stays at that level through the end of the next plan year. It then increases 1% annually for the next 3 years. The minimum employer matching contribution is 100% on the first 1% deferral, and 50% on the next 5%.
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An employer may make a larger match on deferrals up to 6% of pay, but cannot match employee deferrals that exceed 6%. An employer may also stipulate an automatic deferral rate of up to 10% of pay.
In lieu of the employer match, the employer may satisfy the employer contribution requirements by making an unmatched contribution of 3% of pay for all eligible employees.
Vesting. Employer contributions must be 100% vested immediately upon completion of two years of service.
Other Requirements. No minimum service or “last-day-of-year” employment rule is permitted. The automatic deferral amounts must be applied uniformly to all participants.
Notice Requirements. The employer must provide the written notices to participants describing their (i) rights and obligations under the QACA, (ii) the ability to “opt out” of the automatic deferral, and (iii) some details about the default investment. All the information that is required can be provided in a single notice, but must generally be provided prior to the employee first becoming eligible to participate and then at least 30 days prior to the beginning of each plan year thereafter.
Commencement of QACA. Generally, a QACA provision must be adopted prior to the first day of the year to which it is intended to apply, and must remain in effect for the entire plan year. Notice of the adoption must be given to employees not later than 30 days before it goes into effect. Current employees who have (i) a current elective deferral election in place, or (ii) have affirmatively elected not to participate, may be excluded from the default election under a QACA.
Q: I like the automatic enrollment/deferral features but the employer contribution requirements are too expensive. Can we have automatic enrollment without satisfying the minimum employer contribution requirements?
A: Yes you can, but you will not have a safe harbor design and so will still have to apply the annual ADP/ACP testing. It should be noted, however, that any automatic deferral feature should improve your chances of passing the ADP/ACP tests.
Q: I like the automatic enrollment/deferral features but I am concerned that the “escalation” in the automatic employee deferrals is too difficult to administer. Is the escalation each year required?
A: To qualify for the QACA safe harbor and avoid ADP/ACP testing the automatic deferral percentages must be at least the percentages described above for the applicable year in which the employee is subject to the automatic contribution. All escalation could be avoided if the plan started out automatically deferring 6% of the employees pay. Many employers, however, believe that starting at this level may be too “expensive” for employees. Keep in mind, though, that employees are required to receive a notice each year which explains the automatic deferral and employees can affirmatively elect a smaller or no contribution in accordance with the plan’s provisions. Finally, it should be noted that you could have a lower or non-escalating auto-deferral feature that does not comply with the QACA requirements and still utilize the safe harbor design requirements that pre-dated PPA. See the Q&A below.
Q: I don’t like the automatic enrollment/deferral features but would still like to have a safe harbor plan that avoids ADP/ACP testing. Can I still do this?
A. Yes, you can still utilize the pre-PPA safe harbor design and avoid ADP/ACP testing. These safe harbor rules do not mandate any automatic deferrals but they do require greater employer matching contributions.
If you would like to learn more about QACAs or the pre-PPA safe harbor design requirements, please contact me.