Looking for a simple way to increase how much compensation the IRS allows you to contribute to your 401(k) retirement savings plan? Simply enroll all your employees in your firm’s 401(k) plan automatically, unless they say not to.
This approach will generally increase your nonhighly compensated employees’ average deferral percentage, which will allow you , and other highly compensated employees , to increase salary deferrals, too.
The IRS recently clarified that an employer may automatically enroll all eligible employees in its 401(k) plan, provided the employees had the chance to say no, but didn’t.
In 1998, the IRS had ruled that automatic employee contributions to a retirement plan could be considered elective contributions.
The facts in that 1998 ruling involved a newly hired employee, so some people weren’t sure if the rule on automatic enrollment also applied to current employees who had never enrolled in their retirement plans, or had told their plan administrator to take a very small percentage , say, less than 3 percent , out of their pay.
– Applies To Current And New Employees
The recent clarification gives employers the green light for the “negative election” or automatic enrollment approach for both new and longtime employees.
How does an automatic enrollment work? An automatic enrollment 401(k) plan lets you automatically withhold a designated percentage, such as 3 percent, from employees’ paychecks to add to their 401(k) accounts.
Each employee must have the right to say “Don’t touch my paycheck!” if this approach is to work. Thus, employees must have at least one chance each year to tell you to stop taking money out of their pay and put it into the 401(k) plan. The employee’s “negative election” must be in writing.
If your plan makes automatic enrollment irrevocable , meaning employees can never change their minds , the contributions would not be treated as elective deferrals under the 401(k) plan rules.
Since it’s not clear whether the IRS expects annual reminders of employees’ enrollment rights to be part of the automatic enrollment package, it would be a good idea for employers who use automatic enrollment to annually notify employees who have been enrolled automatically that they can discontinue the withholding or choose a different deferral rate.
– Tips For Converting To Automatic System
Tips for converting to automatic enrollment:
- Decide on the default percentage. Keep it low enough so employees won’t immediately opt out of the plan, but high enough to make a difference in your plan testing. Three percent is a common default percentage.
- Highlight the default percentage and matching contribution on paychecks, if applicable.
- Before deferrals begin, pass out a clear explanation of how the program works. Let employees know how they can make and change investment directions, how the contributions will be invested if they don’t make investment directions, and how they can change the amount deferred.
- Make sure you document the whole procedure and get a determination letter from the IRS.
Burson is a partner at Grice, Lund & Tarkington, LLP.
