A provision of the SECURE 2.0 legislation will affect an employer’s decision as to whether to adopt a 401(k) plan or 403(b) plan. The provision requires most 401(k) plans and 403(b) plans (Plans) adopted after the date of enactment of SECURE 2.0 (December 29, 2022) to automatically enroll eligible employees with an automatic contribution that will automatically escalate each year for plan years beginning after 2024.
Exceptions. The legislation gets to being only applicable to new Plans in a round about way. It provides that all Plans must provide the automatic enrollment and escalation as of the effective date. However, all Plans existing on the date of enactment are grandfathered from the requirement as an exception. Additionally, new employers, in existence for less than 3 years, are excepted from the requirement, until their fourth year. There is also an exception for Plans of employers who normally employ 10 or fewer employees until the year after the employer normally employs more than 10 employees. Governmental and church plans are also excepted, as are SIMPLE plans. Interestingly, if an employer with an existing plan on the date of enactment joins a multiple employer plan (MEP), the grandfathering disappears. Each Plan of an employer in the MEP is treated as a separate plan.
Automatic Deferral and Escalation. For plan years beginning after 2024, affected Plans must automatically enroll all eligible employees at a salary deferral rate of at least 3% of compensation but no more than 10%. The participant can elect to opt out or to change the Plan’s stated percentage. The automatic rate is increased 1% annually until reaching at least 10%, but no more than 15%. It is unclear how this works. It appears that this means if the Plan is drafted with an initial automatic deferral of 10%, it would continue the annual automatic escalation until it reached 15%. However, what if the initial deferral rate is only 9%, can it stop at 10%? Regulatory guidance is needed in this regard. Like with the automatic deferral, the participant can change or eliminate the automatic escalation.
Sound Familiar? If this auto-enrollment-auto-escalation sounds familiar to readers in California, it is probably because the state mandated payroll deduction IRA program for employers not maintaining a retirement plan, CalSavers, uses a similar approach.
Guidance Needed. Like many provisions of SECURE 2.0 this provision will need regulatory guidance to be completely understood. I already mentioned the automatic escalation provision above. Another example is, how do you measure how many employees a business “normally” employs?
Conclusion. SECURE 2.0 contains the automatic enrollment provisions because studies consistently show that most employees do not change an automatic enrollment. Therefore, it promotes retirement savings. This is also why many state mandated IRA programs, like CalSavers, also require automatic enrollment and escalation. While choosing the initial deferral rate (between 3% and 10%) is up to employer discretion as a matter of plan design, having to administer automatic enrollment and automatic escalation will be a consideration as to whether an employer desires to adopt a new 401(k) plan or 403(b) plan. Of course, in California, any employer not excepted from this provision of SECURE 2.0, that does not maintain a retirement plan, would have to implement the automatic enrollment-automatic escalation payroll deduction for any employees that do not opt out, under CalSavers. Adopting a profit sharing plan with only employer contributions would be one way to avoid automatic enrollment and escalation. Of course, this means the benefits are funded by employer contributions only.
Stay tuned for more articles on provisions of the massive SECURE 2.0 legislation including provisions encouraging employers to adopt retirement plans and provisions encouraging employees to participate in plans.