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Automatic Enrollment Rules for Businesses

By Stuart Robertson

Automatic Enrollment Rules for Businesses with >10 Employees Starting a 401(k)

Legislation, called Secure 2.0 Act of 2022 (SECURE 2.0), added many new features and rules to help more Americans save for retirement. While small business tax credits , which help more businesses afford 401(k) benefits, grabbed many headlines, the new 401(k) requirement for automatic enrollment is designed to help more Americans with access to a 401(k) use their plan to build for retirement. Automatic enrollment 401(k) plans work to simplify participation in 401(k) plans, and when paired with auto-escalation, help increase deferral rates over time too.

Which Employers with a 401(k) Will Need Automatic Enrollment and When?

401(k) plans established on or after December 29, 2022 are required to have the auto enrollment feature set up by January 1, 2025. Notice 2024-02 regarding the SECURE 2.0 clarifies that a plan is established when the plan provision for elective deferrals is initially adopted, even if the effective date is later. It must include all eligible employees as defined in the 401(k) plan documents.

The following employers and types of business are exempt from this requirement:

  • Any company that established their 401(k) plan prior to December 29, 2022
  • Any small businesses with 10 or fewer employees
  • Newly established businesses: those that have been in existence for less than three years
  • SIMPLE 401(k) plans
  • Church plans and government plans

Currently, businesses starting their first 401(k) that are not exempt will want to include the SECURE 2.0 auto enrollment qualifying feature to avoid the work to add it and put it in place by January 1, 2025.

Do note that any company that merges or spins-off with a plan established before December 29, 2022 remains exempt from the requirement, but may want to consider it given the benefits.

What Is Automatic Enrollment?

Automatic enrollment (aka. auto enrollment) does what you might guess – it automatically enrolls every eligible employee at the company into the 401(k) plan at a set salary deferral percentage. All employees that are not already participating or have not set up their 401(k) account elections are put into a default, diversified portfolio of investments called a Qualified Default Investment Alternative or QDIA. This is typically a model portfolio or target date fund. Employees are not locked in. At any time, employees may change their investment elections, change how much they are deferring to their 401(k) plan, or even opt out of the 401(k) at any time.

Automatic enrollment has proved effective in helping more people start saving for retirement in their 401(k) and is the big reason this part of the legislation was approved.

What is Auto-Escalation?

Auto-escalation provides that each year, an employee’s deferral amount is increased 1% until it reaches a specific limit as determined by the employer and/or regulations.

What Are the Automatic Enrollment Requirements for New 401(k) Plans?

SECURE 2.0 requires that the automatic enrollment initial default rate must be at least 3%. For non-Safer Harbor 401(k) plan designs, an initial default rate of 5% or higher is considered a better starting point to help with passing IRS (Internal Revenue Service) testing. The initial rate must be between 3% and 10%. If the default rate is established at 10%, then auto-escalation is not required. The maximum auto enrollment percent allowed is 15%.

As an example, the employer may set the deferral amount for the autoenrollment at 5% and then each year it will increase 1% until the limit of at least 10% of earnings is met as determined by the employer. The employer may set the maximum salary deferral amount anywhere between 10%-15%.

You may hear this 401(k) plan design referred to as Eligible Automatic Contribution Arrangement or EACA.

Most experts suggest we will need to save 10%-15% of our income over a career to retire at the same standard of living as we were while working, and you can see that the rule of thumb influenced how the legislation was constructed.

Automatic Enrollment Tax Credit

Eligible businesses with less than 100 employees that add automatic enrollment with auto-escalation (EACA plan) can qualify for $500 in tax credits for the first three years after implementing it. That is $1,500 in tax credits over the three years. That’s a nice bonus for adding a powerful feature for your employees and your plan.

The only requirement to be an eligible employer is employing 100 or fewer employees who were paid at least $5,000 in compensation in the preceding year.

Automatic Enrollment Issues and Mistakes to Avoid

You will want to talk to your plan provider about getting your plan ready to add the necessary automatic enrollment features if they have not reached out to you by late September of 2024.

Once automatic enrollment is up and running, the most important thing is to ensure your new eligible employees (typically new hires) are notified and that you add them to your 401(k) systems so that they are auto enrolled. If you forget to add them, you will need to work with your provider to correct for the time the employee was not included. If for a prolonged period, there can be IRS penalties as well.

If you have a qualifying plan that must include automatic enrollment by January 1, 2025, and you do not take the steps necessary in time, the consequences can be significant. Revenue Procedure 2021-30 sets forth a safe harbor method for correcting “reasonable” errors to automatically enroll or escalate employees. Basically, it involves the employer allocating a corrective contribution to affected employees. The corrective contribution amount could be material if the employer improperly excluded a lot of employees for an extended period of time.

Again, please reach out to your plan provider if you believe your plan will need to add this feature by the effective date. A good plan provider will help this go smoothly, and it can be a wonderful thing for your employees who may have been intimidated or unsure about how to save for retirement.

Takeaways:

  • Automatic enrollment is a new required feature as of January 1, 2025th for plans established on or after December 29, 2022nd that have 11 or more employees. The goal is to help more Americans save for retirement.

  • Automatic enrollment adds eligible employees that are not currently participating in your 401(k) plan and sets them at an initial default rate of at least 3%. The initial default rate must be set between 3% and 10%.

  • The deferral amount will increase by 1% for auto enrolled employees who have not adjusted their election until it reaches at least 10%, but it may be set as high as 15%.

  • Employees may opt out or change deferral or investment elections at any time.

  • Businesses currently starting their first 401(k) can benefit from starting an EACA (Eligible Automatic Contribution Arrangement) plan to avoid the hassles of adjusting their plan by January 1, 2025.

  • Employers adding EACA with less than 100 employees can qualify for $500 in tax credits for the first three years of adopting these features.

  • Once you, as the employer, establish the automatic enrollment, be sure to add your newly eligible employees as they are hired or qualify to avoid plan corrections.

  • If you have an existing 401(k) plan that will be impacted by this regulation, be sure to reach out to your provider at least a quarter in advance to ensure the features are ready to roll out on time.


Meet the Author

Our low-cost 401k plans are easy to setup online and are supported by our 401k advisors and specialists. ShareBuilder 401k serves small business and medium-sized companies, as well as the self-employed. We offer Roth 401k, Safe Harbor 401k, Traditional 401k, and Solo 401k options. Your 401k plan is paired with investment management expertise and employee education to help you save more.