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Automatic Enrollment in 401(k)s

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The Pension Protection Act of 2006 relieves employers who automatically enroll employees into 401(k) plans from certain “non-discrimination” rules that would otherwise apply.

Most 401(k) plans require employees to affirmatively choose to put money into a 401(k) plan. In recent years, some employers have instituted “automatic enrollment,” which means that they withhold a certain percentage of their employees’ pay, put it into the 401(k), and then give the employees the opportunity to opt-out of the plan.

To encourage more employers to adopt automatic enrollment, the new law establishes “safe-harbor” 401(k) plans that include certain automatic enrollment features. The employer puts a specified percentage of an employee’s salary into the employee’s 401(k) account unless the employee opts out of participation or chooses a different percentage of salary to contribute to the plan. The percentage automatically withheld must apply uniformly to all employees covered by the plan and must not exceed 10 percent of salary.

One new type of 401(k) plan has an automatic escalation feature. Below is a chart of the minimum percentage that must be withheld according to the number of years an employee participates in the plan.

Percentage withheld from compensation Year of participation in the plan
3% 1
4% 2
5% 3
6% 4

Employers offering this new automatic enrollment 401(k) must also match their employees’ contributions or put money into the plan for all covered employees. If the employer provides matching contributions, the match must be 100 percent of the first one percent of pay and 50 percent of an employee’s contribution up to six percent of pay. If, instead, the employer contributes for all employees, the contribution must be at least three percent of the employees’ pay compensation.  Employees will be fully vested in any employer contribution after two years of service.

Employers who take advantage of the new automatic enrollment provisions will no longer be subject to “nondiscrimination” rules that link the amounts that higher-paid employees can contribute to a 401(k) to the average amounts contributed by lower-paid employees. Under this provision, higher-paid employees may contribute the maximum to the 401(k) plan, even if all of the lower-paid employees chose to opt-out of the plan. Visit our COLA chart to learn the maximum annual contribution limits to 401(k) plans.

Employers have the option to add a withdrawal feature to an automatic enrollment 401(k) plan. This withdrawal feature gives employees 90 days to withdraw their own contributions from the plan without incurring a tax penalty. Without this feature, employees withdrawing contributions could be subject to a 10 percent tax penalty on the amount withdrawn. In addition, the amount withdrawn would be subject to income tax.

The automatic enrollment rules also apply to 403(b) plans provided by nonprofit entities.

The provision took effect in 2008

Read Section 902 of The Pension Protection Act of 2006 (Public Law 109-280).
Read the San Francisco Chronicle article on Automatic Enrollment.

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