The increasing popularity of
salary deferral plans has led to a rise in the number of retirement accounts
that allow participants to self-direct their investments. Participants like
it because it gives them control over their accounts which are at least
partially funded by their own contributions. Employers like it because it
reduces the investment responsibilities of plan fiduciaries.
Sometimes a participant may fail to give investment direction although
the opportunity exists. A fiduciary must then invest the assets on behalf of
the participant. This is more prevalent in plans using an automatic
enrollment feature, which signs up an eligible employee at a specified
deferral rate unless the employee elects otherwise. If election forms are
not returned, the account is established and contributions are placed in a
default investment.
In non-safe harbor plans, automatic enrollment can help passage of the
average deferral percentage (ADP) and average contribution percentage (ACP)
tests by increasing plan participation. This can result in higher
contributions being allowed for highly compensated employees (generally
owners and those earning over $100,000 in 2007). It also results in more
money being saved for retirement which is beneficial in light of concerns
about the social security system.
The Pension Protection Act of 2006 (PPA) created an "eligible automatic
contribution arrangement" effective in 2008. Among other things, it requires
default investments to meet certain guidelines. The Department of Labor
(DOL) recently issued final regulations for a "qualified default investment
alternative" (QDIA). This article will take a close-up look at the QDIA
provisions and how they apply to automatic enrollment arrangements.
Automatic Enrollment
The most common use of QDIAs will be under automatic enrollment
provisions when employees fail to return participation election forms. But
they can also be used any time a participant fails to exercise the right to
direct investments.
PPA established criteria for eligible automatic contribution arrangements
under which salary deferrals to a 401(k), 403(b) or 457(b) plan could be
automatically deducted at a specified rate unless the employee elects not to
have the deduction or elects a different rate. Employees must receive a
notice within a reasonable time before their eligibility and prior to each
plan year explaining their right to elect not to participate or a different
deferral rate from the default election. It must also explain how
contributions will be invested in the absence of their election.
Participants may be given a 90-day period during which they can request a
return of their deferrals deducted without their election pursuant to an
automatic enrollment program.
Plans that meet the eligible automatic contribution arrangement
requirements are subject to relaxed rules for correcting a failed ADP or ACP
test. This includes the extension of the 2½-month period for penalty-free
corrective distributions to six months. In addition, fiduciaries are granted
liability protection by using the default investments provided under the
QDIA rules.
PPA also provided for a "qualified automatic contribution arrangement"
which, like safe harbor 401(k) plans, automatically satisfies the ADP and
ACP tests, as well as the top heavy requirements. The default election must
be at least 3% the first year, 4% the second, 5% the third and 6% thereafter,
not to exceed 10%. In addition, the employer must make either a 3%
non-elective contribution for all non-highly compensated employees
(generally non-owners and those earning less than $100,000 in 2007) or a
match contribution of 100% of the first 1% deferred and 50% of the next 5%
deferred. Employer contributions must be fully vested after two years of
service.
The final regulations reiterate that any state law that directly or
indirectly prohibits or restricts the inclusion in any plan of an automatic
contribution arrangement is pre-empted by ERISA as amended by PPA.
Qualified Default Investment Alternative (QDIA)
Employers who want to implement automatic enrollment can now do so
without concern over fiduciary liability. Adherence to the guidelines of the
final regulations will protect plan fiduciaries from exposure resulting from
investment losses.
The new regulations were designed to meet the long-term retirement
savings needs of each employee. A plan must meet the following requirements
to satisfy the QDIA provisions:
- Assets must be invested in one of the allowable QDIA categories (see
below);
- Participants must first be given an opportunity to provide investment
direction;
- A notice must be provided to participants containing information about
the QDIA and how to obtain information about the other investment options
under the plan (see below);
- Materials concerning the QDIA investment, such as mutual fund
prospectuses and proxy voting rights, which would normally be provided to
participants allowed to self-direct, must be furnished to participants;
- Participants must be given the opportunity to transfer their QDIA
investment to any other investment option allowed under the plan as often
as the plan allows transfers by those who exercise investment control, but
not less frequently than once within any three-month period;
- No fees or expenses can be charged for transfers or permissible
withdrawals out of a QDIA during the first 90 days; and
- The plan must offer a broad range of investment alternatives in
accordance with ERISA section 404(c) which governs participant-directed
accounts.
Allowable Investment Alternatives
In order to be considered a QDIA, the investment must be in one of the
following categories:
- A mix of investments that takes into consideration a participant’s
age, projected retirement date or life expectancy (such as a life-cycle or
target-retirement-date fund);
- A mix of investments which bases its investment risk on the
participants of the plan as a whole (such as a balanced fund); or
- A professionally managed account that is diversified and considers the
participant’s age, projected retirement date or life expectancy.
With certain exceptions, employer securities cannot be part of a QDIA.
In addition, a capital preservation investment, such as a money market
account, may be utilized during the first 120 days after which time it must
be transferred into one of the three alternatives described above. This will
preserve the principal in the event the participant requests a refund during
the 90-day revocation period provided by some auto enrollment programs.
Investments that meet these guidelines will provide fiduciary protection
under ERISA section 404(c) as if participants had exercised control over
such assets. However, as is the case with all 404(c) participant-directed
accounts, fiduciaries must still prudently select and monitor any qualified
default investment alternative under the plan.
QDIA Notice
The notice to participants must be written in a manner expected to be
understood by the average participant and contain the following information:
- A description of the circumstances under which a participant’s account
may be invested in a QDIA and, if applicable, the circumstances under
which deferrals will be deducted and contributed to the plan under an
automatic enrollment program, including the deferral percentage and the
participant’s right to elect a different percentage or to decline
participation;
- An explanation of the right of participants to direct the investment
of the assets in their individual accounts;
- A description of the QDIA, including investment objectives, risk and
return characteristics (if applicable) and any fees and expenses;
- A description of the right of participants whose accounts are invested
in a QDIA to direct the investment of those assets to any other investment
alternative available under the plan, including any restrictions, fees or
expenses applicable to such transfer; and
- An explanation of where participants can obtain information about
other investment alternatives under the plan.
The notice must be distributed at least 30 days prior to a participant’s
eligibility; 30 days before the first QDIA investment; or anytime up to the
eligibility date if the participant can exercise the 90-day permissible
withdrawal option in an automatic enrollment program. In addition, the
notice must be given out at least 30 days prior to each subsequent plan
year.
Effective Date
The QDIA rules take effect on December 24, 2007. Default investments made
prior to that date will be "grandfathered" if they meet certain requirements
of guaranteed principal, rate of return and withdrawal without fees or
surrender charges.
Conclusion
The DOL’s final regulations on QDIAs provide welcome guidance for
employers utilizing automatic enrollment provisions in their salary deferral
plans. Fiduciaries will now be protected when they establish default
investments that meet the new guidelines. Now that these rules are in place,
it is expected that automatic enrollment will significantly increase
participation in salary deferral plans in the coming years.
IRS and Social Security Annual Limitations
Each year the U.S. government adjusts the limits for qualified plans and
social security to reflect cost of living adjustments and changes in the
law. Many of these limits are based on the “plan year.” The elective
deferral and catch-up limits are always based on the calendar year. Here are
the 2008 limits as well as the three prior years for comparative purposes:
|
| Maximum compensation limit |
$230,000 |
$225,000 |
$220,000 |
$210,000 |
| Defined contribution plan maximum
contribution |
$46,000 |
$45,000 |
$44,000 |
$42,000 |
| Defined benefit plan maximum benefit |
$185,000 |
$180,000 |
$175,000 |
$170,000 |
| 401(k), 403(b) and 457 plan maximum elective deferrals |
$15,500 |
$15,500 |
$15,000 |
$14,000 |
| Catch-up contributions* |
$5,000 |
$5,000 |
$5,000 |
$4,000 |
| SIMPLE plan maximum elective deferrals |
$10,500 |
$10,500 |
$10,000 |
$10,000 |
| Catch-up contributions* |
$2,500 |
$2,500 |
$2,500 |
$2,000 |
| IRA maximum contributions |
$5,000 |
$4,000 |
$4,000 |
$4,000 |
| Catch-up contributions* |
$1,000 |
$1,000 |
$1,000 |
$500 |
| Highly compensated employee threshold |
$105,000 |
$100,000 |
$100,000 |
$95,000 |
| Key employee (officer) threshold |
$150,000 |
$145,000 |
$140,000 |
$135,000 |
| Social security taxable wage base |
$102,000 |
$97,500 |
$94,200 |
$90,000 |
*Available to participants who are or will be age 50 or older by the
end of the calendar year.
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