Small business and start-up owners should weight the pros and cons of automatic enrollment for retirement plans.
Small business owners today often bear a large burden when it comes to wearing many hats and juggling many roles. An increasingly popular option for small businesses and start-ups looking to simplify retirement planning, automatic enrollment encourages employees to save for retirement by requiring them to opt out of plan contributions – it makes savings the default, not a special option. Designed in part to increase plan participation, this option also provides tax incentives for many businesses, among other benefits.
Whether you are launching a new plan or considering updates to your company’s current retirement plan, it is worthwhile to take a look at expanded automatic enrollment options.
Getting qualified: What you should know about QACAs
The Qualified Automatic Contribution Agreement (QACA) is an auto-enrollment 401(k) plan with “safe harbor” provisions that exempt plans from anti-discrimination testing requirements. With a QACA, employers make matching contributions and are required to vest both matching and non-elective contributions in two years.
Under this option, businesses must offer a schedule of minimum default percentages that start at three percent and increase from there; the default deferred contribution must increase each year to at least six percent, with a maximum of 10% in any plan year.
- A matching contribution of 100% of the employee’s contribution, up to 1% of compensation, as well as a 50% matching contribution for contributions above 1% of compensation up to 6% of compensation or
- A non-elective contribution of 3% of compensation to all employees, including those who do not contribute to the plan.
Additionally, any employee can update contribution amounts or choose to opt out. Likewise, employers can make further contributions – and update contribution amounts – annually.
Qualified Automatic Contribution Agreements: Why or why not?
As with any other plan option, there are pluses and minuses to consider before implementation.
In the positive column, QACAs:
- Bolster participation in your retirement plan while helping employees increase their retirement savings; this can enhance overall job satisfaction and employee retention;
- Create a safe harbor to prevent anti-discrimination testing for businesses that allow employees to defer the maximum amount;
- Deliver notable tax advantages for those subject to corporate tax (including the deduction of employer contributions). Employees may also benefit from tax deferral;
- Simplify the contributions process and investment options for retirement – a system that can be overwhelming for many.
On the other hand, there are downsides to consider:
- When employee participation in a plan increases, so does the cost of matching contributions, so it is wise to examine projected costs ahead of launching a QACA;
- While auto-enrollment can be simpler in the long run, it will require new communication materials when you add it as well as more work for the payroll team initially. Depending on the size of your business, this may be a notable burden;
- Employees may be confused by the default rate and whether that amount is the right contribution for them; they may also think this amount will lead to ample retirement savings when it may only supply a fraction of their long-term needs.
Small businesses and start-ups can manage the last issue through something called automatic escalation, which is also typically established as an opt-out option. This process automatically increases the percentage employees invest in their retirement plan each year, encouraging more savings up to 10% of their pretax earnings. Workers can always opt out if they need to dedicate the funds elsewhere. This escalation process provides an alternative to QACA and does not require an employer contribution.
Similar but different: QACA vs. EACA
Sometimes confused for each other, both qualified automatic contribution agreements and Eligible Automatic Contribution Agreements (EACA) were created by the Pension Protection Act of 2006 to expand worker participation in retirement plans. In sum, eligible automatic contribution agreements entail simpler requirements than QACAs: Employees automatically contribute a specific and uniform percentage of their overall pay to the employer’s qualified investment plan following the required notice. If employees do not make a specific investment selection – which is not uncommon under EACAs – employers must enroll them in the same plan with the same contribution rate as those who do provide enrollment instructions.
With an EACA, employees can withdraw contributions by providing an election no earlier than 30 days or no later than 90 days after the first automatic enrollment contribution is withheld.
Both options involve a uniform percentage of pay for the deferral percentage, however, an EACA does not include an automatic increase or escalation for employees. Eligible automatic contribution agreements do not have minimum or maximum automatic deferrals (as compared with 3%/at least 6% and up to 10% for QACAs). The employer contribution is required for QACAs, but not EACAs.
Adopting auto-enrollment in your small business or start-up
If you decide to move forward with auto-enrollment, you will need to determine whether to use a professional institution or establish the plan yourself. Regardless, you will need to:
- Create and adopt a written plan, which explains and establishes the foundation of your plan;
- Establish a trust for the assets of the plan to ensure they are used solely for participants and beneficiaries;
- Initiate a recordkeeping system to track contributions, earnings/losses, expenses and more; and
- Share information with employees.
The QACA should explain the enrollment process and the automated aspect as well as the right of employees to abstain from enrollment; the agreement must also list the deferral percentage and the right to update that amount. QACAs must be launched at the beginning of a plan year, and companies must create a plan amendment if they choose to add this feature to a current plan.
If you are unsure what direction to take with your company’s retirement plan, you can compare options on the IRS Tax Information for Retirement Plans site.
Ultimately, retirement plans help individuals and businesses save and plan for the future. Auto-enrollment can simplify this process, encourage stronger savings and foster employee loyalty to a small business or start-up. If you are considering updating your retirement plan offerings, talk with your plan advisor, attorney or accountant to determine if a QACA and auto-enrollment is right for your organization.