United States: Employee Benefits Report: The Pension Protection Act of 2006—New Automatic Enrollment Provisions

The Pension Protection Act of 2006 (the "PPA," the "Act") was signed by President Bush on August 17, 2006.  The Employee Benefits practice group of Thelen Reid & Priest LLP has issued a series of reports that summarize selected provisions of the Act.  The following is the third in the series and discusses provisions for new plan contribution arrangements.

The PPA provides for new "qualified automatic enrollment contribution arrangements" intended to increase plan participation.  The new rules generally apply to 401(k) plans and 403(b) annuity contracts and are effective for plan years beginning after December 31, 2007.  Some rules are generally applicable to plans with automatic enrollment features, even those that chose not to adopt "qualified automatic enrollment contribution arrangements."

Although existing law allows automatic enrollment or "negative elections" whereby participant contributions are withheld by the employer unless the employee elects otherwise, the new law makes automatic enrollment more appealing under new "qualified automatic contribution arrangements."  A "qualified automatic contribution arrangement" must meet requirements regarding automatic deferrals, matching or nonelective contributions, and an employee notice, summarized as follows:

Automatic Deferrals.  An employee who has not made a written election to participate or to opt out must be automatically enrolled, and is treated as having elected to make an elective contribution of at least 3% of compensation the first year, increasing by 1% annual increments to 6% during the fourth and subsequent years.  A plan may provide for a qualified contribution percentage of up to 10%.  The automatic deferral election will cease if an employee makes an affirmative election to opt out or to have contributions made in an amount different from the stated percentage under the "qualified automatic contribution arrangement."

Matching or Nonelective Contributions.  An employer must either make matching contributions of 100% of the first 1% of compensation plus 50% of the next 5% of compensation (but not to exceed 6% of compensation), or, alternatively an employer can make non-elective contributions of at least 3% of compensation for all non-highly compensated eligible employees.  Employees must be 100% vested after two years of service.

Notice Requirement.  An annual written notice must be given explaining an employee's election rights and how contributions under the automatic contribution arrangement will be invested in the absence of an investment election by the employee.

A plan with a "qualified automatic contribution arrangement" under the Act is treated as meeting the actual deferral percentage ("ADP") test with respect to elective deferrals, and the matching contribution percentage requirements ("ACP") test with respect to matching contributions.  In addition to this new safe harbor for nondiscrimination testing, the Act exempts a plan with a "qualified automatic contribution arrangement" from the top-heavy rules.

Some employers have been reluctant to implement automatic enrollment because of state garnishment and payroll withholding laws.  The Act responds to those concerns and broadly preempts any State law that would directly or indirectly prohibit or restrict the inclusion in a plan of an automatic contribution arrangement. This provision applies both to plans with "qualified automatic contribution arrangements" and to plans with other automatic enrollment features as long as certain notice and other election requirements are met.  As an exception to the effective date for rules dealing with automatic enrollment, the change regarding preemption is effective on the date of enactment.

An employee who fails to make an election and is automatically enrolled may subsequently opt out and withdraw automatic contributions (with earnings) made during the first 90 days.  Such a withdrawal is not subject to the 10 percent tax under Code section 72(t).  Withdrawn contributions (and earnings) are includible in the employee's gross income in the year of distribution; any employer matching contributions are forfeited.  This provision is not limited to plans with automatic enrollment features that meet the requirements for "qualified automatic contribution arrangements."

Plans with automatic enrollment features, including those with "qualified automatic contribution arrangements", now have six months instead of two months from the end of the plan year to distribute corrective distributions without incurring excise tax.

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