AICPA Comments on Automatic Contribution Arrangement Proposed Regs.

The Pension Protection Act of 2006, P.L. 109-280 (PPA ’06), made it easier for plan sponsors to automatically enroll participants in 401(k), 403(b), and 457(b) plans. Last November, the Service released proposed regulations on the tax aspects of automatic enrollment of participants in cash or deferred arrangements (REG-133300-07).

The AICPA has several concerns about the regulations as proposed and sent a letter to the IRS on February 1, 2008, outlining those concerns.

First, the AICPA has asked the Service to clarify what amount should be distributed under Sec. 414(w) when an employee has elected to contribute an amount in excess of the default amount. If the employee later decides to no longer make 401(k) contributions and elects to withdraw any contributions (assuming the plan allows for this under Sec. 414(w)), it is unclear how much should be distributed to the employee. Prop. Regs. Sec. 1.414(w)-1(c)(3)(i) specifies that the distribution must be equal to the default elective contributions. This appears to require that the distribution be based on the 3% default contribution rate of Prop. Regs. Sec. 1.401(k)-3(j)(2)(ii)(A) and not include any additional amount contributed by the employee. It also seems under the proposed regulations that only the employer match on the 3% default rate would be forfeited, but the match on any excess contributions would not be subject to forfeiture (Prop. Regs. Sec. 1.414(w)-1(d)(2)). The AICPA suggests that the final regulations clarify these points.

Second, the AICPA has asked that the final regulations include a grace period for the employee notice requirements for new hires who are immediately eligible to participate in a plan. The preamble to the proposed regulations states that the notice requirement can be met by providing notice to the employee on his or her first day of employment. The AICPA is concerned that this gives employers no leeway (some, for example, may not perform new-employee orientation on the first day of employment). It also does not give employees a reasonable period before the first contribution is made. The AICPA has asked for a grace period, such as two weeks from the date of hire, for employers to meet the notice requirements.

Third, the AICPA has asked for clarification of how employees who have not made an affirmative election in a preexisting plan should be treated when a qualified automatic contribution arrangement (QACA) is instituted. Sec. 401(k)(13)(C)(iv) provides that automatic contributions are not required for employees who were eligible to participate in the plan immediately before the QACA was put in place and who had an election in effect on that date either to participate or not to participate. With respect to these employees, Prop. Regs. Sec. 1.401(k)-3(j)(1)(iii) states that automatic contributions are not required if these employees had affirmative elections in effect to have elective contributions made or not to have elective contributions made.

This rule appears to treat employees who simply made no election at all (and thus no elective contributions were made to the plan on their behalf) as not having made an affirmative election to have no contributions made; therefore, automatic contributions are required for these employees. The AICPA has requested that the final regulations state that, for purposes of Sec. 401(k)(13)(C)(iv), in an ongoing plan adopting QACAs, an employer could treat employees who made no election in the past as having elected not to participate (thereby treating the failure to make an affirmative election to participate as, in effect, an election not to participate). Thus, automatic contributions would not be required for employees already eligible under the plan but not participating.

Fourth, the AICPA has asked that the final regulations explicitly address whether the actual deferral percentage test of Sec. 401(k)(3)(A)(ii) and actual contribution percentage test of Sec. 401(m)(2) are satisfied for the entire plan as a result of the QACA, even though not all plan participants must be covered under the automatic contribution feature. The AICPA also requested that the final regulations explicitly address whether em-ployer contributions required for a QACA under Sec. 401(k)(13)(D)(i) (i.e., matching or nonelective contributions) are required for all employees, including those for whom automatic contributions are not required.

Finally, the AICPA has requested that the notice content requirement for the eligible automatic contribution arrangement (EACA) and QACA notices should be similar to the relief given in Notice 98-52 to the required safe-harbor notices for plan years beginning before January 1, 2000. This relief stated that a notice will not fail to satisfy the content requirement for that plan year, merely because the notice does not include all of the required items, if the notice satisfies a reasonable good-faith interpretation of the statutory requirements. Due to the complexity of EACAs and QACAs and the short time period to implement them, the AICPA believes it is appropriate to provide transitional relief for plan years beginning in 2008.