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ACAs and EACAs and QACAs, Oh My!

The goal of this article is to make these arrangements a lot less scary than lions and tigers and bears. Our friends in Washington, D.C. are very fond of using acronyms to simplify what are often times quite complicated rules. Such was—and remains—the case with automatic enrollment features which were whole-heartedly embraced by Congress with the passage of the Pension Protection Act of 2006 (“PPA”). Policymakers were hopeful that these measures would boost defined contribution plan participation and help employees save more for retirement.

What is an ACA? It is an Automatic Contribution Arrangement (not to be confused with “the ACA” which is also an acronym for the Affordable Care Act). Traditionally, employees had to affirmatively elect to receive cash compensation or save part of it in their employer’s retirement plan via a 401(k), 403(b) or governmental 457(b) deferral feature. Employers that adopt auto-enrollment provisions encourage employees to save money (and likely, taxes) by making compensation deferrals to the plan the default, requiring them to affirmatively opt-out of contributing. ACA provisions may be added to an existing plan at any time during the plan year and they may apply to all eligible employees, a subset of such employees or new hires only. Automatic increases to the initial default rate may optionally be included in the provisions. Proper and timely initial, as well as, annual notices must be provided to affected employees which explain the provisions. In addition, the normal non-discrimination testing (i.e. ADP/ACP Tests) apply to a “vanilla” 401(k) plan with ACA provisions—the results of which should be noticeably improved thanks to greater participation levels.

What is an EACA? It is an Eligible Automatic Contribution Arrangement, an ACA with a few twists. EACA provisions must start at the beginning of a plan year and they may provide for an up-to 90-day (from the date of first default contribution) permissible withdrawal period. This optional period may be as short as 30 days and addresses the issue of participants who are unhappy with their defaulted deferrals from compensation. Employee contributions (plus earnings) may be refunded upon request and any associated employer matching contributions must be forfeited and neither would be included in plan year end non-discrimination testing. Speaking of testing, only refunds for a failed ADP or ACP Test made after six—extended from the normal two and one-half—months beyond the end of the plan year would be subject to the 10% employer excise tax. The EACA must cover all eligible employees in order to take advantage of this advantageous six-month correction rule, however.

What is a QACA?It is a Qualified Automatic Contribution Arrangement, an ACA with more than a few twists and which may be an EACA as well. It is pronounced just like the sound a duck makes with an “A” on the end—one of our favorite acronyms! QACAs are an interesting hybrid of auto-enrollment, auto-increase and safe harbor provisions (see:What is a Safe Harbor 401(k) Plan? ) Plan?). The minimum default rate is 3% of compensation and this deferral rate must increase at least 1% each year to at least 6%, but not exceed a maximum of 10%. In addition, there are a couple of optional liberalizations to the traditional safe harbor rules. First, the minimum QACA matching formula may be reduced to 100% of the first 1% of compensation deferred plus 50% of the next 5% of compensation deferred (i.e. 3-1/2% match for a participant deferring 6% of compensation as opposed to a 4% match for a participant deferring 5% of compensation under a traditional safe harbor plan utilizing the basic matching formula). Second, the applicable QACA employer matching or non elective (i.e. 3% of compensation to all participants) contributions may besubject to a maximum two-year vesting schedule (i.e. “cliff” or “graded”) as opposed to the immediate 100% vesting required under a traditional safe harbor plan. Furthermore, ADP/ACP testing would not apply to a plan with these special safe harbor provisions.

Please refer to this month’s Building Blocks of ERISA for a chart which briefly compares these three types of Automatic Contribution Arrangements.

ACAs have been widely embraced and largely successful in meeting the goals of increased participation and retirement savings—especially in the mid to large 401(k), 403(b) and governmental 457(b) marketplaces. In fact, plans that contain automatic enrollment features routinely see participation rates in excess of 90% as opposed to the more common 60% range for plans in which eligible employees must opt-in. These arrangements are not without their downsides, however, and those include the increased possibility for errors in administering the unique automatic provisions including the notice requirements, the potential for an undesirable amount of small account balances for terminees and those who opt-out early and increased employer matching contributions.

Automatic enrollment/escalation provisions—which would require automatic investment choices as well—present unique plan design opportunities and, given the appropriate circumstances, have proven to be very useful. In consultation with their 401(k), 403(b) or governmental 457(b) plan service providers, plan sponsors should consider if adopting these design features would be a good fit for them and work with counsel to be sure they are implemented properly. Each plan sponsor’s philosophies, goals, demographics and financial situations are unique and must be examined before committing to the requirements applicable to automatic contribution arrangements.

Please feel free to contact our Firm if you would like to discuss any of the foregoing information in greater detail. We would welcome the opportunity to consult with you.

© Boutwell Fay LLP 2018, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of September 28, 2018.

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