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New automatic enrollment regulations: Great benefits, unfortunate timing

By Rob Smith, Ceridian manager of Government Relations

Since 401(k) plans were introduced in the 1980s, most plan sponsors have taken the salad bar approach to plan design: choice, choice and more choice. Apart from being able to choose whether to participate in a 401(k) or similar plan, employees usually have a wide variety of investment options, and plan sponsors have been keen to allow them to make their own decisions regarding how their retirement savings are allocated.

A wealth of choice may be one of the mainstays of American culture. However, in a recently released study by the Government Accountability Office (GAO) on the U.S. workforce's retirement savings, it appears that this relative freedom has allowed many to make disastrously wrong choices for their futures.

In a November 2007 report, the GAO estimated that 34 percent of future retirees will have no money saved for retirement. And among lower-income workers, approximately 65 percent will have no money put away in a retirement account. If left unchecked, this trend could be particularly terrifying for younger workers who may not be able to count on as much support from Social Security and Medicare as current retirees.

Help on the way?
Thankfully, our nation's current and impending retirement crisis isn't new news to the federal government. Last year, President Bush signed into law the Pension Protection Act (PPA) of 2006. The PPA aims to address many of the factors that have led workers toward unfunded retirements and more years at work. Now, nearly a year later, the U.S. Treasury Department and the IRS have released proposed regulations that will allow employers to implement these much-needed changes.

One of the main issues with 401(k) plans is that employees simply choose not to enroll in them. Retirement accounts were provided as a matter or course under the old defined-benefits system until the mid-1990s when they became too expensive for employers to maintain. But 401(k) plans and similar defined-contribution plans depend on workers making an affirmative election to participate in them. This decision is often difficult for younger workers whose retirements are 40 or 50 years away and for lower-income workers who may struggle with monthly bills.

Under the PPA, employers will be provided with a new automatic enrollment option that gives them added flexibility to enroll new workers and existing employees who have not elected either to participate or not participate in a plan. As long as employers follow the regulations, they qualify for a "safe harbor" from burdensome non-discrimination and top hat testing that has kept employers from assisting employees with their retirement accounts in the past.

To qualify, employers must divert 3 percent of workers' salaries to a 401(k). Employers are required to fully match the first 1 percent and provide a 50 percent match for the next 2 percent. In subsequent years, employers can divert up to 10 percent of workers' salaries into their 401(k) accounts, but they are only required to provide the 50 percent match up to 6 percent (a total 3.5 percent match), which would fully vest in two years. Alternatively, employers can fully match employees' initial 3 percent deferral without providing additional matches in later years.

The PPA provides employees enrolled in an automatic contribution plan 90 days to opt out of the plan and withdraw their money without paying the 10 percent federal restricted distribution penalty.

Payroll departments take note
The opt-out provision is particularly important to payroll departments because the law did not provide guidance on when the 90-day period begins and ends or how to return employees' salary deferrals if they decide to opt out of the plan.

The new regulations make it clear that the 90-day clock starts ticking on the date of an employee's first deferral to the automatic plan. The employee then has 90 days to elect to withdraw those contributions. This withdrawal election will be effective on the last day of the payroll period in which the election was made.

The IRS chose not to issue guidance regarding when employers need to return these withdrawals to employees, but assumes that employers will treat them as they would any other withdrawal from a 401(k) or similar account. However, the amount of the refund must be adjusted for investment gains and losses. Employers are allowed to reduce the distribution for fees that are generally applied to other distributions. Employees who opt out of the plan after the 90-day period must have their money returned to them on or before the date they terminate employment.

New notices required
The proposed rules also lay out automatic enrollment notice requirements employers must follow to qualify for the safe harbor. Employers must provide eligible employees written notice describing how the automatic enrollment plan works, how the employees' contributions will be invested, what other investments are available under the plan, how to adjust their account investments and how to opt out of the plan.

This notice must be provided to all new hires and to all individuals who have not made an election to participate or not participate at least 30 days or "within a reasonable amount of time," before the employee would make salary deferrals into the automatic enrollment plan. However, as a "reasonable amount of time" is not defined, employers should use the 30-day advance notice as a benchmark. Employers are also required to send a similar annual notice to employees enrolled in the automatic plans at least 30 days, but no more than 90 days, before the beginning of each plan year.

The IRS has posted a sample notice on www.irs.gov.

The proposed regulations are open for comments until February 2008 and are expected to be finalized within the year, but employers can begin relying on them immediately.

Quick turnaround may affect adoption
These notice requirements place a tight time crunch on employers who plan to take advantage of the PPA's new automatic enrollment plans for plan year 2008. The IRS and U.S. Treasury regulations were not released until November 7, 2007. This gives employers very little time to digest the requirements, put a qualified plan into place and send out the required notices.

Under the 30-day requirement, an employer that wanted to implement an automatic enrollment plan beginning January 1, 2008, would have had to issue a notice on December 1, only three weeks after the proposed regulations were released.

The U.S. Treasury and IRS regulations are fairly lengthy and complex. Three weeks is little time to read and understand the regulations, much less implement them. Many employers may simply choose to forgo offering an automatic enrollment plan for 2008 rather than expose themselves to potential plan disqualification and making costly corrective distributions. There is some hope that the government will issue transitional guidance to address these concerns, but that remains to be seen.

Employees can't afford to sit 2008 out
Many workers' retirements are in serious jeopardy and need help as soon as possible. The PPA automatic enrollment provisions just might be the cure for America's poor savings habits. Several studies have shown that these arrangements can boost plan participation to over 90 percent.

We've had a year to mull over the opportunities the PPA presents, but a law without regulations is like owning an expensive new home theater system without the instructions that explain how to use it and what's involved in setting it up. Employers should be encouraged to make the much-needed change to automatic enrollment plans, and the government could go a long way toward accomplishing that goal by affording employers more time to implement the IRS and U.S. Treasury regulations.