In an earlier article, we discussed recently passed legislation that provides tax credits for businesses using automatic enrollment as a feature in their retirement plan. As a brief refresher, with automatic enrollment once an employee is eligible for the 401(k) plan, instead of signing up they are automatically enrolled in the plan at a previously determined percentage of their wages. Of course, this process is disclosed to the employee at least 45 days before they’re eligible for the plan. Additionally, the employee can completely opt-out of the 401(k) plan or opt to contribute a different percentage or dollar amount.
Automatic enrollment is an efficient tool to help employees grow their retirement savings. With employers being enticed to add automatic enrollment by receiving a $500 per year tax credit for 3 years, it’s time to figure out which automatic enrollment option makes the most sense for your business. Just like the three iconic ice cream flavor – vanilla, chocolate, and strawberry – employers have three automatic enrollment options; Automatic Contribution Arrangement (ACA), Qualified Automatic Contribution Arrangement (QACA) and Eligible Automatic Contribution Arrangement (EACA).
The Automatic Contribution Arrangement (ACA) is like your plain, yet classic, vanilla version of automatic enrollment. With ACA an employee will be automatically enrolled at a certain percentage of pay unless they opt otherwise. This is a streamlined and simple automatic enrollment option.
Next, we turn our attention to the proverbial chocolate ice cream, the Qualified Automatic Contribution Arrangement (QACA). Just like the variety that chocolate ice cream offers (chocolate fudge, German chocolate, dark chocolate); you’ve got options! QACA has three very intriguing features: automatic escalation, a vesting schedule, a 90 day permissible withdrawal option, and an employer contribution. This article offers a brief overview of QACA, which can be a powerful benefit for the right company. If you would like a more in-depth explanation, please contact us at email@example.com.
With QACA every employee must be automatically enrolled in the plan at least at a 3% deferral rate. If enrolled at a rate of less than 6%, the employee’s contribution must be automatically increased annually by at least 1% per year to at least 6%. Of course, the employee could always opt-out of the automatic escalation. To ease the administration of the automatic escalation requirement we like to just automatically enroll the employees at 6% to start.
Because QACA is a Safe Harbor, which can help the highly compensated employees max out their contribution, an employer contribution must also be made. The employer can choose between either a 3% non-elective contribution to all eligible employees regardless of whether they contribute or not or a match. This match is a 100% match up to 1% of employee contributions and 50% of the next 6%. That’s a mouthful so the below chart might help clear that up:
If the employee contributes 1%, the employer will match 1%
If the employee contributes 2%, the employer will match 1.5%
If the employee contributes 3%, the employer will match 2%
If the employee contributes 4%, the employer will match 2.5%
If the employee contributes 5%, the employer will match 3%
If the employee contributes 6%, the employer will match 3.5%
The employer won’t match on more than 6%. However, by using the match instead of the non-elective employer contribution, the employee needs to contribute in order to receive the company contribution.
Turning our attention to the 90-day permissible withdrawal, all employees must receive the automatic enrollment notice at least 45 days prior to being automatically enrolled. For those employees who “forgot” that they’d be automatically enrolled but didn’t opt-out or select a different deferral amount, they can withdrawal those 401(k) contributions from the plan. There are a few interesting rules with the withdrawal in that it must take place within 90 days of the employee being automatically enrolled. Interestingly, there are no early distribution tax penalties on this withdrawal for employees under the age of 59 and a half (the employee will be subject to income tax on the withdrawal). This permissible withdrawal feature provides quite a bit of flexibility for an employer who wants to enroll their employees in the plan. It allows the newly enrolled employee to defer, but if the employee wants to stop and remove their money, they can.
The final piece to the QACA puzzle is a vesting schedule. Yes, you heard that right, a vesting schedule on a Safe Harbor formula! The most stringent vesting schedule for QACA is a 2-year cliff:
Year 1: 0% vested
Year 2: 100% vested
This vesting schedule can be a great way for businesses with high turnover to offer a retirement benefit upfront while rewarding and encouraging longer term employment.
The last flavor of automatic enrollment we’re going to dive into is the Eligible Automatic Contribution Arrangement (EACA), and just like strawberry ice cream, it can be sweet! EACA is very similar to ACA in the fact that an employee is automatically enrolled at a set percentage of salary – and they can always opt-out. However, what makes EACA attractive is the option for a 90-day permissible withdrawal option similar to QACA. What’s sweet about EACA is that is only utilizes the 90-day permissible withdrawal feature of AQCA without the complexity of vesting schedules or automatic escalation. EACA can be ideal for an employer who wants to add automatic enrollment but doesn’t want the additional administrative complexities of QACA.
If you have any questions about how these three flavors of automatic enrollment could benefit your employees, Kampstra Wealth Management is more than happy to provide a retirement plan design illustration. Please contact us at firstname.lastname@example.org or (717) 334-0097.