Source: https://www.americanbar.org/groups/real_property_trust_estate/publications/probate_property_magazine_home/rppt_mo_premium_rp_publications_magazine_2008_so_RetirementBenefits.html
Timestamp: 2017-12-16 20:35:45
Document Index: 344358218

Matched Legal Cases: ['§ 401', '§ 404', '§ 401', '§ 414', '§ 404', '§ 624', '§ 2550', '§ 401', '§ 401', '§ 401', '§ 1', '§ 401', '§ 1', '§ 1', '§ 401', '§ 401', '§ 401', '§ 416', '§ 902', '§ 401', '§ 1', '§ 72', '§ 414', '§ 1', '§ 1', '§ 4979', '§ 902', '§ 54', '§ 404', '§ 1', '§ 404', '§ 2550', '§ 2550', '§ 2550', '§ 2550', '§ 414', '§ 2550', '§ 2550', '§ 2550', '§ 514', '§ 414', '§ 502', '§ 514']

Negative Elections—Positive Effects
Before the enactment of section 902 of PPA 2006 (the Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780), the Internal Revenue Service had ruled that an employer could reduce an employee’s compensation by a certain amount and have that amount contributed as an elective deferral to the employee’s Code § 401(k) plan, provided that the employee was given notice that the employee could file an election with the plan to have no compensation reducing contribution (or a different amount of contribution) made. The plan involved also provided for an annual notice to each employee of his or her salary reduction percentage (if any) and right to modify it. Rev. Rul. 2000-8, 2000-1 C.B. 617, amplifying and superseding Rev. Rul. 98-30, 1998-1 C.B. 1273. The use of the automatic contribution technique, sometimes referred to as “negative” or “default” elections, in theory causes a greater number of employees to participate in the employer’s 401(k) plan and/or at a higher level than would be the case if an affirmative action by the employee were required. In turn, the increased employee participation might allow the employer’s highly compensated employees to make greater affirmative deferral elections under the average deferral percentage (ADP) tests governing discrimination in contributions to 401(k) plans. Rev. Rul. 2000-8 notes that the Department of Labor had advised the Treasury Department that the provisions of ERISA § 404(c) that may serve to relieve certain fiduciaries from liability when participants exercise control over the assets held in individual accounts (that is, direct investments) would not apply when the participant is merely apprised of investments that will be made in his or her behalf in the absence of instructions to the contrary.
Although it may seem counterintuitive that the use of negative elections would have a significant effect, the power of inertia appears to have produced increased participation, particularly among low- and middle-income employees, in the relatively small number of plans that have used the technique. A number of studies, some of which have been reproduced on the web site of the Brookings Institution, www.brookings.edu, and testimony regarding these studies, undoubtedly helped frame the provisions of the Pension Protection Act described below that expressly provide for qualified automatic contribution arrangements (QACAs), eligible automatic contribution arrangements (EACAs), and qualified default investment arrangements (QDIAs). These arrangements provide additional incentives to include negative elections in 401(k) plans and provide detailed operating rules for their implementation. Under these rules, contributions may be made to a passive participant’s 401(k) account in increasing amounts, and the amounts contributed may be invested throughout the employee’s period of employment (and beyond) with the only action that need be taken by the employee being to discard the annual notices that advise the employee that affirmative elections may be made to change the contributions rates and investment choices.
Proposed Treasury Regulations were issued on November 8, 2007, for qualified automatic contribution arrangements under Code § 401(k)(13) and for eligible automatic contribution arrangements under Code § 414(w). REG-133300-07, 72 Fed. Reg. 63,144 (Nov. 8, 2007). According to the preamble to the Proposed Regulations, taxpayers may rely on the Proposed Regulations pending the issuance of Final Regulations. Department of Labor Final Regulations under ERISA § 404(c)(5), as amended by PPA 2006 § 624(a), which set forth the requirements for qualified default investment alternatives, were issued on October 24, 2007. DOL Reg. § 2550.404c-5, 72 Fed. Reg. 60,452 (Oct. 24, 2007).
Effective for plan years beginning after 2007, section 902 of PPA 2006 amends the Code to provide for a new safe harbor under the rules for nondiscrimination in contributions for a 401(k) plan that contains a QACA. Such a plan is treated as meeting the actual deferral percentage test for elective deferrals and the actual contribution percentage test for matching contributions such that no annual testing for discrimination is required. Code §§ 401(k)(13) and 401(m)(12). To qualify for the QACA safe harbor, the 401(k) plan must meet three requirements—an automatic deferral requirement, a matching or nonelective contribution requirement, and a notice requirement.
To meet the automatic deferral requirement, the 401(k) plan must provide that, unless an employee elects otherwise, the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation, not in excess of 10% and equal to at least 3% of compensation for the first year that the deemed election applies to the participant, 4% during the second year, 5% during the third year, and 6% during the fourth year and thereafter. In addition to not applying to any employee who affirmatively elects not to have such contributions made or to make elective contributions at a different level, automatic contributions are not required to apply to any employee who was eligible to participate in the arrangement (or a previous arrangement) before the automatic enrollment feature was added to the plan and had an election in effect either to participate or not participate in the arrangement. Code § 401(k)(13)(C). The qualified percentage must apply uniformly to all eligible employees (allowing for the difference in the number of years of participation in the QACA) except for variations to limit the amount of elective contributions so as not to exceed the Code’s contribution limits under Code §§ 401(a)(17), 402(g), and 415, to continue the rate of elective contributions already in effect for a participant on the effective date of the QACA, or to provide for a zero percentage during a period following a participant’s receipt of a hardship distribution when elective contributions are prohibited. Prop. Treas. Reg. §§ 1.401(k)-1(d)(3) and 1.401(k)-3(j)(2)(i)(A).
A QACA meets the matching or nonelective contributions requirement if either
• without regard to whether an employee makes an elective contribution to the 401(k) plan, the employer makes a contribution to a defined contribution plan for each nonhighly compensated employee who is eligible to participate in the 401(k) plan in an amount equal to at least 3% of the employee’s compensation, or
• the employer (1) makes a matching contribution for each nonhighly compensated employee equal to 100% of the employee’s elective deferrals that do not exceed 1% and 50% of the employee’s elective deferrals that exceed 1% but do not exceed 6% of compensation and (2) the rate of match for any elective deferrals for highly compensated employees is not greater than the rate of match for nonhighly compensated employees. Code § 401(k)(13)(D)(i).
A plan with an automatic enrollment feature that makes the above matching contributions will be considered to satisfy the actual contribution percentage (ACP) test for matching contributions for purposes of the QACA safe harbor as long as (1) no matching contributions are provided for elective deferrals in excess of 6% of compensation, (2) the rate of matching contributions does not increase as the rate of an employee’s elective deferrals increases, and (3) the rate of matching contributions for any rate of elective deferral of a highly compensated employee is no greater than the matching contribution rate for the same rate of deferral of a nonhighly compensated employee. Prop. Treas. Reg. § 1.401(m) 3(a)(2), referring to Treas. Reg. § 1.401(m)-3(d). Under Code § 401(k)(13)(D)(iii), an employee who has completed two full years of service must be fully vested in benefits derived from employer contributions and the restrictions on distributions and withdrawals that apply to elective deferrals also must apply to such employer contribution derived benefits.
As compared to the matching contributions under non-QACA-design-based safe harbor for meeting the ADP/ACP tests under Code §§ 401(k)(12) and 401(m)(11), the QACA safe harbor under Code §§ 401(k)(13) and 401(m)(12) requires a slightly lower level of matching contributions once a participant has phased in to the 6% match level. In addition, if the 401(k) plan meets the QACA requirements for elective and matching contributions, the plan will be excluded from the definition of a top-heavy plan as well. Code § 416(g)(4)(H), as amended by PPA 2006 § 902(c). These are the incentives intended to encourage employees to adopt QACAs and thus encourage the greater retirement savings the law is intended to promote.
QACA Notice Requirements
Within a reasonable period before each year, each employee eligible to participate in a QACA must receive written notice sufficiently accurate and comprehensive to inform the employee of the employee’s rights and obligations written in a manner calculated to be understood by the average employee to whom the arrangement applies. The notice must
• explain the employee’s right to elect not to have elective contributions made on the employee’s behalf (or to elect to have contributions made at a different percentage);
• if the arrangement provides that the employee may elect among two or more investment options, explain how the employee’s contributions will be invested in the absence of an election; and
• allow the employee a reasonable period of time after the receipt of the notice and before the first elective contribution is made to make an election for contributions and/or investments. Code § 401(k)(13)(E); Prop. Treas. Reg. § 1.401(k)-3(k)(4).
EACAs establish rules for the permissible withdrawal of automatic contributions without penalty and compliment the required QACA provisions if the contribution discrimination safe harbor is desired or apply independently to a non-safe-harbor automatic contribution arrangement. If an employee elects to withdraw elective contributions to an EACA (and the earnings attributable to them) within 90 days of the date of the first elective contribution:
• the amount of the withdrawal (except for a designated Roth contribution) is includible in the employee’s gross income for the employee’s taxable year in which the distribution is made;
• no 10% tax on early distributions is imposed under Code § 72(t);
• the automatic contribution arrangement is not treated as violating any restriction on distribution under the Code solely by virtue of allowing the withdrawal; and
• in the case of a distribution correcting an excess contribution or excess aggregate contribution, employer matching contributions are forfeited or subject to such treatment as the IRS may prescribe. Code § 414(w)(1) and (2); Prop. Reg. § 1.414(w)-1(c) and (d).
The date of an employee’s first elective contribution is the date on which the compensation subject to the cash or deferred election would otherwise have been included in the employee’s gross income. An election to withdraw automatic elective contributions must be effective no later than the last day of the payroll period that begins after the date of the withdrawal election. Prop. Treas. Reg. § 1.414(w)-1(c)(2). Under Code § 4979(f), as amended by PPA 2006 § 902(e), the excise tax on excess contributions made to automatic contribution arrangements does not apply if the excess contribution or excess aggregate contribution, together with allocable earnings, is distributed or forfeited within six months after the close of the plan year. Such distributed amounts are includible in the employee’s gross income in the taxable year in which the distribution occurs. Prop. Treas. Reg. § 54.4979-1(e)(1).
To qualify as an EACA, each employee eligible to participate in the arrangement must receive a notice containing all of the elements of the notice required to be given in the case of a QACA described above but must also (1) state that, in the absence of an investment direction, automatic (and matching) contributions will be invested in accordance with the regulations under ERISA § 404(c)(5) discussed below and (2) describe the employee’s right to make a permissible withdrawal and the procedures to elect such a withdrawal. The notice is required to be provided at least 30 days and no more than 90 days before the beginning of each plan year, or in the case of an employee who becomes eligible to participate during a plan year (or within the 90-day period preceding a plan year), no more than 90 days before the employee becomes an eligible employee and no later than the date the employee becomes an eligible employee. Prop. Treas. Reg. § 1.414(w)-1(b)(3).
If specific requirements are met for plan years after 2006, a 401(k) plan participant whose contributions (whether automatic or not) and earnings are invested in the absence of a participant election in accordance with QDIA regulations will be treated as exercising control over the assets in his or her account. ERISA § 404(c)(5)(A). Note that, while the participant’s deemed control over the assets protects a plan fiduciary from liability for investment losses, the fiduciary continues to be responsible for the prudent selection and monitoring of the QDIA. DOL Reg. § 2550.404c-5(b). To qualify for fiduciary protection:
• the invested amounts must relate to the account of a participant who had the opportunity to direct the investment of the account but failed to do so;
• a notice, written in a manner calculated to be understood by the average plan participant, must be given to each affected participant describing (1) the circumstances under which assets in the participant’s account may be invested in a QDIA (and, if applicable, an explanation of automatic contributions and the ability to opt out or change contribution limits), (2) the right of the participant to direct the investment of the account assets, (3) the QDIA itself, including a description of the investment objectives, risk, and return characteristics (if applicable), and fees and expenses attendant to the investment alternative, (4) the right of the participant to direct the investment of the assets in the QDIA to any other investment alternative under the plan (at least quarterly) as well as any restrictions, fees, or expenses in connection with a transfer, and (5) the location of investment information concerning the other investment alternatives available under the plan;
• the fiduciary must provide to the participant the materials relating to the account investments required by DOL Reg. § 2550.404c-1, such as proxy statements, prospectuses, and so on;
• the participant must be able to transfer all or a portion of the account out of the QDIA in accordance with the plan’s rules for investment elections without additional restrictions, fees, and expenses; and
• the plan must offer a broad range of investment alternatives within the meaning of DOL Reg. § 2550.404c-1(b)(3). DOL Reg. § 2550.404c-5(c)(2) through (6).
The initial notice to the participant described above must be provided either (1) at least 30 days in advance of the later of the participant’s date of plan eligibility or the date of the first investment in a QDIA or (2) if the participant has the opportunity to make a permissible withdrawal under Code § 414(w), on or before the date of plan eligibility. DOL Reg. § 2550.404c-5(c)(3).
QDIA Alternatives
Three types of investment alternatives may be used under the regulations as qualified default investment alternatives:
1. an investment fund product or model portfolio that applies generally accepted investment theories, is diversified so as to minimize the risk of large losses, and that is designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures based on the age, target retirement date, or life expectancy of the participant (for example, a “life cycle” or “target-retirement-date” fund);
2. an investment fund or model portfolio that applies generally accepted investment theories, is diversified so as to minimize the risk of large losses, and that is designed to provide long-term appreciation and capital preservation through a mix of equity and fixed income exposure consistent with a target level of risk appropriate for participants in the plan as a whole (for example, a “balanced fund”); or
3. an investment management service under which an investment manager, applying generally accepted investment theories, allocates the assets of each participant’s account to achieve varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures offered through investment alternatives under the plan based on that participant’s age, target retirement date, or life expectancy but does not necessarily take into account the individual’s risk tolerance, investments, or other preferences (for example, a “managed account”). DOL Reg. § 2550.404c-5(e)(4)(i) through (iii).
A temporary QDIA (for a period of 120 days after a participant’s initial plan contribution) may be an investment product or fund designed to preserve principal and provide a reasonable rate of return consistent with liquidity and is offered by a state or federally regulated financial institution (for example, a “capital preservation fund”). DOL Reg. § 2550.404c-5(e)(4)(iv).
Unified Notice
The IRS has issued a sample “Automatic Enrollment Notice” on its web site at www.irs.gov/pub/irs-tege/sample_ notice.pdf for a hypothetical QACA that satisfies the requirements for both a QACA and an EACA. In FAB 2008-03, issued on April 29, 2008, the Department of Labor confirmed that the notice proposed by the IRS also satisfies the QDIA notice requirements. FAB 2008-03, Q&A 8 and Q&A 9. ERISA § 514(e), as amended by PPA 2006, preempts any state law that would directly or indirectly restrict the inclusion in any plan of an automatic contribution arrangement and defines an automatic contribution arrangement as requiring a notice that is generally the same as the EACA notice under Code § 414(w)(3). Note that under ERISA § 502(c)(4), the penalty under ERISA for the failure to provide the notice required under ERISA § 514(e)(3) to any employee is $1,100 per day.