Automatic Enrollment 401(k) Plans for Increased Employee Participation

In a traditional 401(k) plan election procedure, employees complete and file election forms instructing their employer to reduce their cash compensation by an amount that is to be contributed to the 401(k) plan. Under a new election procedure, a 401(k) plan may provide that employees will automatically participate and have a set percentage or amount of their compensation contributed to the 401(k) plan, unless the employee makes an affirmative election to receive cash instead. Initial indications are that 401(k) plans utilizing the new election procedure have increased participation rates, with some employers reporting participation rates in the high ninety percent range.

Until recently, there was concern that the IRS might not consider an employee to be making a cash or deferred election under these automatic enrollment plans. The IRS set that concern to rest in Revenue Ruling 98-30. The IRS states that an employee will be considered to be making an election between contributing to the 401(k) plan or receiving cash if the employee has an effective opportunity to elect to receive cash. This means that the employee must have a reasonable amount of time to elect to receive cash prior to having compensation deferred from the employee's paycheck and contributed to the 401(k) plan pursuant to an automatic election.

The revenue ruling discusses a specific factual situation, outlined below, that the IRS finds to constitute an acceptable cash or deferred election procedure. Please note that plans do not have to exactly track the facts of the revenue procedure in order to have an acceptable automatic election feature.

Revenue Ruling 98-30 involves a 401(k) plan under which a newly hired employee's compensation will be reduced by 3%, unless the employee affirmatively elects to receive cash or to have a different percentage contributed to the plan. At the time the employee is hired, the employee receives a notice that explains the automatic compensation reduction election and the employee's right to elect to have no compensation or a different amount of compensation contributed to the 401(k) plan. The employee is subsequently notified on an annual basis of the amount of the employee's compensation reduction percentage and the employee's right to change the percentage.

Employers in North Carolina need to be aware that the North Carolina General Statute Section 95-25.8 may not allow for an automatic election process. The statute specifically provides that an employer may not take a payroll deduction except in accordance with the employee's written authorization. With an automatic election, there is no written authorization. It is not clear whether ERISA preempts this state statute (i.e., overrides it with respect to qualified retirement plans). Employers considering an automatic election process need to obtain guidance regarding this issue and similar employment law issues, including minimum wage laws.

Employers who wish to add an automatic election process to their plans likely will need to amend their plan documents, as most plans require written elections. Further, the employers will need to prepare notice forms communicating the automatic enrollment process to employees. Finally, employers who allow participants to direct investments will need to determine how 401(k) plan funds will be invested pending receipt of the automatically enrolled participant's investment election. 

For more information, please call or e-mail the attorneys in Poyner & Spruill's Employee Benefits Section

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The purpose of this Web site is to provide general information about legal developments. Because the facts in each situation vary, any legal precedents noted may not be applicable to individual circumstances. This information is not offered as legal advice.