Client Alert

The Internal Revenue Service (“IRS”) and U.S. Department of Labor (“DOL”) have recently issued regulations which encourage plan sponsors to automatically enroll employees for participation in 401(k) retirement plans.

Under the Pension Protection Act (“PPA”), employers may automatically enroll employees in 401(k) plans for plan years beginning after December 31, 2007. If the plan meets certain requirements set forth in the PPA, it is exempt from nondiscrimination testing applicable to 401(k) plans. On November 7, 2007, the Internal Revenue Service (“IRS”) issued proposed regulations designed to assist employers in obtaining the safe harbor protection if the automatic enrollment feature is utilized. Under the proposed regulations, plans meeting these requirements are referred to as "qualified automatic contribution arrangements" (“QACA”).

The IRS regulations explain many of the provisions contained in the PPA, such as the required minimum amounts of the automatic contributions and the minimum matching amount required from the employer. The regulations also provide additional guidance on the notice obligations for a QACA. If the plan is currently in existence, but will be amended to provide automatic enrollment, the plan must be amended prior to the first day of the plan year and remain in effect for an entire 12-month plan year. The plan must also provide additional notice to each eligible participant before the beginning of each plan year that informs him of his right to opt out of the automatic enrollment or change the amount of his contribution. Additionally, the notice must also inform the participant how his contributions will be invested should he fail to provide such guidance.

In another move to encourage automatic employee participation in 401(k) plans, the DOL has issued final guidance for fiduciaries to avoid liability when making default investments. If plan fiduciaries follow these guidelines in making investments when a participant fails to provide investment directions regarding their contributions, the participant will be deemed to have exercised control over the investments thereby relieving the plan fiduciary from liability for any investment loss experienced. The default investment guidance applies in any situation in which a participant is permitted to provide investment direction for his contributions and fails to do so, regardless of whether he affirmatively elected to make such contributions or was automatically enrolled in a plan.

The DOL regulations provide that in order to qualify for this treatment, the plan’s investment must be managed by an ERISA fiduciary, such as an investment manager, the plan trustee, the plan sponsor, or an investment company registered under the Investment Company Act of 1940. The contributions must be invested in a qualified default investment alternative, such as a target maturity fund, balanced fund or a managed account. Stable value funds or money market funds may only be used as a default for 120 days after the contributions begin. Thereafter, if the employee has not elected out of enrollment or provided alternative investment direction, the funds must be transferred to a target maturity fund, balanced fund or a managed account in order for the fiduciary to be relieved from liability for the investment.

Additionally, in order to qualify for relief from liability, the plan fiduciary must provide notice to the participant at least 30 days prior to the date of plan eligibility regarding the default investment. Such notice must include a description of the circumstances under which default investments will be made; explain the participant’s right to provide investment decisions; describe the default investment, including the investment objectives, risks, returns, expenses, and applicable fees; and provide information to assist a participant in obtaining more information on investment alternatives available under the plan.

Finally, the DOL regulations also address an issue which arises under many states laws affecting automatic enrollment in a 401(k) plan. Many state laws provide that an employer violates wage payment laws if it makes deductions from an employee's paycheck without the employee’s written consent. The DOL regulations make clear that if a plan has provided an employee with notice of the automatic enrollment in compliance with the PPA and its applicable regulations, the employer does not violate state wage payment laws by making deductions from the employee's paycheck without his specific written consent.

The IRS has published a sample notice that plan sponsors may use to inform participants about their rights under a QACA. The sample notice also contains text that will satisfy the information requirement for participant notices under the DOL regulations on qualified default investment alternatives. See this link for a copy of the sample notice.

If you have any questions regarding this client alert, please contact the Womble Carlyle attorney with whom you usually work or one of our Employee Benefits attorneys.