Automatic enrollment in Secs. 401(k) and 403(b) plans.

• Author: Adkins, G. Edgar, Jr.

One of the primary objectives of the Pension Protection Act of 2006 (PPA '06) was to increase employee participation in defined-contribution plans, by facilitating automatic enrollment in Secs. 401(k) and 403(b) plans. Under automatic enrollment, an employee is automatically enrolled in the plan, with a prescribed percent of his or her pay automatically withdrawn from his or her paycheck.

Surveys indicate that participation and contribution rates are significantly higher in plans that use automatic enrollment; see, e.g., Holden and VanDerheis, "The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k)Accumulations at Retirement," EBRI Issue Brief No. 283 (July 2005). Further, the plan nondiscrimination rules are eliminated if the employer adopts automatic enrollment in a way that meets certain requirements. These factors will almost certainly entice many employers to implement the automatic-enrollment feature.

Use of Automatic Enrollment

In the past, there were at least two major barriers to the use of automatic enrollment. First, some states prohibit automatic deductions from an employee's pay. The PPA '06 addressed this, by providing that all state laws that prohibit automatic enrollment are preempted by Federal law, effective on the PPA '06's enactment. Second, employers have had significant concerns about the fiduciary responsibility and liability for the investment of contributions made to the plan through automatic enrollment. The Department of Labor (DOL) issued proposed regulations in September 2006 to address these concerns (DOL Prop. Reg. Section 2550. 404c-5), and is expected to issue final regulations in early 2007.

Nondiscrimination Rules

For plan years beginning after 2007, plans that offer automatic enrollment and meet certain requirements are exempt from the usual nondiscrimination tests that apply to employees' elective deferrals and employer matching contributions. These tests are referred to as the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test (as described in Sec. 401 (k) (3)(A)(ii) and (m) (2)(A), respectively), and are used to ensure that Secs. 401(k) and 403(b) plans do not discriminate in favor of highly compensated employees (HCEs).The ADP test applies to employees' elective deferral contributions; the ACP test applies to an employer's matching contributions. Sec. 401(k) plans are subject to both the ADP and ACP tests, while Sec. 403(b) plans are...