Updated August 24, 2023
While SECURE 2.0 stopped short of mandating automatic enrollment for all workplace savings plans, it included this requirement for new retirement savings programs established upon its enactment. Here is a brief breakdown of this new rule, its implications, and the steps to consider.
Automatic enrollment has been around since the late 1990s. Since then, research has repeatedly demonstrated that when employers deploy automatic enrollment and automatic increase features in their retirement savings programs, employees significantly improve their financial prospects in retirement. Still, auto features did not gain wider adoption until the Pension Protection Act of 2006 (PPA) addressed one of the major concerns of employers by creating a legal liability shield when auto-enrolled employees’ funds were invested in qualified default investment alternatives (QDIA). PPA also popularized two plan design options for 401(k) and 403(b) plans, Eligible Automatic Contribution Arrangement (EACA) and Qualified Automatic Contribution Arrangement (QACA).
The New Rule
Up to the point of SECURE 2.0 passage, auto-enrollment remained optional, left to the employer’s discretion. Beginning with the 2025 plan year, however, 401(k) and 403(b) plans established after December 28, 2022, must offer an Eligible Automatic Contribution Arrangement (EACA), sweeping in employees by default unless they opt out. Retirement plans in existence before December 29, 2022, are exempt from the mandate; they may continue their existing enrollment programs (whether they are automatic enrollment or traditional opt-in enrollment). Also exempt from the mandate are retirement plans maintained by businesses that normally have 10 or fewer employees and retirement plans of businesses less than three years old. IRS guidance is needed to clarify the rules when transitioning from exempt to non-exempt, and to define ‘normally’ for this purpose. Governmental and church plans, SIMPLE 401(k) and SIMPLE IRA plans are also excluded from requirement.
Auto-features Prescribed by SECURE 2.0
The new rules require the following features be included in the auto-plans:
- The initial (default) contribution rate must fall between 3% and 10% of compensation and apply uniformly to all employees enrolled automatically. However, employees retain the right to modify their savings rate to a higher or lower percentage or to stop deferrals altogether.
- Automatic escalation will need to increase the initial default savings rate by 1% annually on the first day of the plan year until it reaches at least 10% up to the maximum of 15%. Employees may adjust the savings rate or opt out of the increase. Note: Auto escalation may be avoided by setting the initial default contribution percentage at 10%.
- Withdrawal rights should allow auto-enrolled employees to withdraw their earnings-adjusted contributions within 90 days after the employee’s first automatic enrollment contribution was withheld. These amounts are subject to income tax but free of the 10% early withdrawal penalty.
- Investment in QDIA is required. Auto-enrolled contributions must be placed in a qualified default investment alternative (QDIA) selected in line with the Department of Labor’s (DOL) guidance unless an employee affirmatively chooses different investments. Note: Funds may be held in a a stable value or money market fund for up to 120 days after the date of the participant’s first elective contribution.
Items of Note
- Employer Contributions: While not required, employers may fund matching and non-elective contributions, including safe harbor contributions, which allow a free pass for employee deferral and/or employer contribution amounts compliance tests.
- Additional Time to Correct Annual Compliance Tests: Plans subject to compliance testing that measures deferral amounts and match amounts of highly paid and non-highly paid employees get more time to process 10% penalty-free corrective distributions when required, six months compared to the usual two-and-a-half month deadline.
- Correction for Failures: To address concerns over potential operational failures in the implementation of auto-enrollment features, SECURE 2.0 has made permanent a self-correction option for errors in administering auto-enrollment, giving employers up to 9 1/2 months after the plan year-end to fix a variety of mistakes on favorable terms without first seeking approval from the IRS (read more about new self-correction options here).
- Long-term Part-time Employees: SECURE 2.0 requires 401(k) and 403(b) plans to allow part-time employees with two consecutive years with at least 500 hours worked to make salary deferral contributions beginning in 2025. No exception for auto-enrollment of LTPT employees is provided currently (read more about new long-term, part-time employee rule here).
- Who Should be Auto-enrolled: It is unclear if the new automatic arrangement must cover all eligible employees, or may be limited to the newly eligible ones. Historically, plans were allowed to apply auto-enrollment to only newly eligible employees or those without an election not to participate. IRS guidance is required on this point.
- Not all available auto-enrollment designs meet the new requirement: Such designs would likely require amendments to conform them to the terms specified in SECURE 2.0. For example, while the deferral feature of a Qualified Automatic Contribution Arrangement (QACA) satisfies the SECURE 2.0 terms, plans may require an amendment to cover all participants as required by the new law. (Reminder: Plans in existence before December 29, 2022 are exempt altogether and may continue current programs.)
- Notice requirements: Employees will be required to receive the required communications informing them about the automatic enrollment and escalation, procedures to change savings rates or the right not to participate in the plan with opportunity to make a withdrawal within 90 days, and the default investments used. For calendar year plans impacted by the mandate, the annual notice period runs October 3 – December 2; at least 30 and no more than 90 days before the plan year begins. Newly-eligible employees will need to receive the notice, electronically or on paper, no earlier than 90 days before eligibility conditions are met and no later than the date of eligibility.
- Tax credit: To encourage adoption by small businesses, SECURE 1.0 created a special tax credit for adding automatic enrollment to a retirement plan. For this purpose, a small business is an employer with 100 or fewer employees paid at least $5,000 in the preceding year. The $500 credit is available for each of the first three years the auto-features are effective (read about the new tax credits here).
Actions to Consider
- Review and Amend Plans: Unless an exemption is available, ensure your current plan aligns with the new requirements. The amendment deadline is the end of the first plan year starting on or after January 1, 2025 (though practical considerations may require the amendment before the 2025 plan year begins).
- Consider Earlier Implementation: Coordination between HR, payroll systems and investment platform providers takes time.Those able to implement the auto provisions sooner may benefit from the lead time to work out the necessary process changes, making it easier to address the details than when dealing with the requirement once it becomes effective in 2025.
- Watch for Guidance: With several nuances requiring clarification and potential unintended consequences, it is important to monitor new IRS guidance to ensure full compliance.
The SECURE 2.0 Act’s auto-enrollment mandate is a significant step towards encouraging more employees to save for retirement. While it introduces added complexities for employers, with proper planning and communication, these changes can be seamlessly integrated into existing retirement savings programs. As always, staying informed and proactive is key.
Let Pinnacle Plan Design Help
Consultants at Pinnacle Plan Design are actively monitoring new guidance concerning SECURE 2.0. This represents our understanding of the laws at this time. Additional guidance will provide additional clarity. If you have any questions about automatic enrollment and escalation features and how these requirements may impact you, don’t hesitate to contact us at (520) 618-1305.