Happy Returns

One of the “promises” of the newly enacted Pension Protection Act of 2006 (PPA) is that it will foster, if not encourage, greater levels of retirement plan participation. And while there are several areas that ostensibly facilitate this growth – notably the removal of EGTRRA’s sunset provisions and the expansion of investment advice – the thing that is really supposed to make a difference is automatic enrollment.

So, how does the PPA encourage automatic enrollment? First, it resolves the current dilemma faced by plan sponsors in states that prohibit (or appear to) deductions from a worker’s pay without their explicit permission. While this has been a relatively recent concern, the certainty that federal, not state, law governs these transactions is a welcome relief, and one that is provided immediately. Will it persuade employers who were not already actively considering automatic enrollment? Probably not.

The PPA also lays the groundwork for some much-anticipated clarity from the Department of Labor on the issue of an appropriate default investment election. Still, there seems little doubt that, when we do see the final rules, the DoL will officially embrace the use of some form of asset allocation vehicle. Of course, we were expecting this even if the PPA didn’t pass. Consequently, it will help tidy things up, but isn’t likely to transform current trends. This will be effective for plan years beginning in 2007.

Ironically, the biggest change – and it won’t take effect until 2008 – is the creation of something called a “qualified automatic contribution arrangement.” Implementing this special version of automatic enrollment exempts a plan from both top-heavy and average deferral percentage (ADP) testing (ACP - average compensation percentage – testing as well, if applicable). To qualify, a plan has to implement the program for all eligible workers prospectively; automatically defer in accordance with a schedule stated in the law (see Pension Reform Influences Automatic Enrollment Designs ); match those contributions (the law specifies a schedule); 100% vest those matching contributions within two years; give participants notice of the program, the default options, and their right to opt out in a timeframe that gives them an opportunity to do something different – oh, and it must provide for that initial contribution to be increased annually in accordance with another provision in the law.

In my initial reading of the law, this was the provision that I found most questionable. Not in its ultimate result, or goal – but it struck me as making things just complicated enough mathematically to slow, not speed, the adoption of automatic enrollment. Why? Not the match requirement itself, or the vesting applied to that match – both are comparable in effect to the current safe harbor provisions (there are differences, however). No, what may make a difference to many plan sponsors, IMHO, is the requirement to increase those employee deferrals – and, at least potentially, the employer match associated with those deferrals.

The impact of the latter is obvious – and cost concerns alone may well keep plan sponsors from taking advantage of the option. The former – the decision not only to take money from workers’ paychecks without their involvement, but to increase that initial deferral – could be just as problematic. While I have found that plan sponsors generally are in favor of the concepts behind automatic enrollment, they are less inclined – at present, anyway – to combine that decision with taking even more from those paychecks without “permission.”

On the other hand, workers retain the ability to opt out at any time. They don’t appear to do so very frequently – but that option remains for anyone who truly can’t afford it (or thinks they can’t). But one of the larger concerns for plan sponsors with automatic enrollment is the accumulation of small balances – those deferrals that workers don’t notice until three paychecks later, at which point they stop the deferrals, but then discover that “I wasn’t paying attention to the automatic enrollment notices” doesn’t qualify as a reason for hardship withdrawal.
That’s why, IMHO, one of the real gems in the PPA is the ability, within 90 days of that first contribution, to return those contributions to the worker. In my experience, the inability to do so under current law has been perhaps the largest impediment to these programs – and its inclusion in the new law may make all the difference in the world.