MARCH 2007 Pension Plan tip of the month...

AUTOMATIC ENROLLMENT (March, 2007)

As part of our continuing efforts to keep you informed, we want to make you aware that the Pension protection Act of 2006 (PPA) has made some significantly beneficial changes to facilitate “Automatic Enrollment” or “Negative Election Enrollment” in qualified retirement plans.   Two major enhancements were:

1. “Preemption” of state laws; some states have wage payment laws requiring employee consent to any deductions from wages
2. Fiduciary protection in selecting a “qualified default investment alternative” (QDIA) should a participant not specifically direct their selection of investments

Notification requirements must be met. This method of enrollment is not designed to change the decision-making process that most eligible employees go through to join the 401(k) Plan. Rather, its purpose is to prompt those eligible employees who would not otherwise decide to join the Plan to contribute by having the employer make an automatic deferral election, generally starting at a deferral rate of around 3% or 4%, on their behalf.

Approximately 20% of the largest 401(k) plans are automatically enrolling participants and this legislation will most likely increase this percentage.

Potential benefits include:

·         Increase of overall plan’s contribution rate 

·         Increased contribution rates help the plan pass nondiscrimination testing

·         Employees may be more likely to accrue larger balances

·         Increased plan value could result in lower overall plan fees

There are also a number of issues to consider before implementing this option. Some of these are:        

·             The Plan must be amended to allow this provision

·             Will automatic enrollment include all eligible or only newly eligible employees

·             Increased employee notification is required

·             Internal tracking of employees that were default enrolled

·             The default % selected may be less than what employees would typically defer

·             May be difficult to promote if you have geographic/or language barriers

·             Cost of matching contributions could increase

·             Administration time and expense of additional small balances could increase due

              to the creation of numerous small balances

·             Beneficiary information should still be collected and maintained

·             Will the automatic deferral increase option be utilized each year

·             Increased number of balances for terminated employees not taking a distribution could require plan to have an audit

Safe Harbor - Automatic enrollment provisions

This provision will become effective for plan years beginning after 12/31/07.

In addition to the benefits listed previously, potential benefits include:

·         Plan is exempt from ADP, ACP and Top heavy tests

There are also a number of additional issues to consider before implementing this option. These other added provisions will include: 

·         Safe harbor automatic enrollment must apply to ALL ELIGIBLE employees, unless

          they previously made an affirmative election to join or opt out.  The plan sponsor

          will need to identify these employees

·         Minimum automatic deferral % selected must be at least the following:

              1st year – 3%,   

              2nd year – 4%,

              3rd year – 5%,   

              4th year – 6%

             Please note that this provision could be difficult to administer.

·          Employer contributions are required

Matching contribution of at least: 100% on first 1% plus 50% of next 5%.   (Example: if an employee defers 6% or more, his match will be 3.5% of pay) 

OR

Profit Sharing equal to 3% of pay

Regardless of the employer contribution method selected, it must be 100% vested after the employee has completed 2 years of service.

Other automatic enrollment provisions

These provisions will become effective for plan years beginning after 12/31/07 for qualified automatic enrollment arrangements

·         Revocation of enrollment or “erroneous automatic contributions” – an employee

          can request that deferrals are returned within 90 days after the date the first

          automatic deferral is withheld form their paycheck.  Please note that this will be

          quite a challenge administratively and to date, there is not any substantial

          guidance on how this will take place

·         For non safe harbor plans, the deadline for returning excess contributions under

          ADP/ACP testing will be 6 months instead of 2.5 months

Every plan and every employer is unique and this provision may not be feasible in all situations. If you would like to explore this option for your plan, please contact your plan’s investment advisor, legal counsel, or your Paragon Account Executive.