Management / Small Business

Small Business Guide to Automatic Enrollment 401k Plans

Operating An Automatic Enrollment 401(k) Plan

Once you have established a plan, you assume certain responsibilities in operating the plan. If you hired someone to help in setting up your plan, that arrangement also may have included help in operating the plan. If not, another important decision will be whether to manage the plan yourself or to hire a professional or financial institution — such as a bank, mutual fund provider, or insurance company — to take care of some or most aspects of operating the plan. Elements of operating automatic enrollment 401(k) plans include the following:

  • Participation
  • Contributions
  • Vesting
  • Nondiscrimination
  • Investing the contributions
  • Fiduciary responsibilities
  • Disclosing plan information to participants
  • Reporting to government agencies
  • Distributing plan benefits


Employees are automatically enrolled in the plan and a specific percentage will be deducted from each participant’s salary unless the participant opts out or chooses a different percentage. Typically, a plan includes a mix of rank-and-file employees and owner/managers.

However, as with any 401(k) plan, some employees may be excluded if they:

  • Have not attained age 21;
  • Have not completed a year of service; or
  • Are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining.

Employees cannot be excluded from a plan merely because they are older workers.


Basic and Eligible Automatic Enrollment 401(k) Plans – As with any 401(k) plan, in addition to employee contributions, you decide on your business’ contribution (if any) to participants’ accounts in your plan. If you decide to make contributions to your automatic enrollment 401(k) plan for your employees, you have additional options. You can match the amount your employees decide to contribute (within the limits of the law) or you can contribute a percentage of each employee’s compensation (called a nonelective contribution) or you can do both. You have the flexibility of changing the amount of matching and nonelective contributions each year, according to business conditions.

Qualified Automatic Contribution Arrangements (QACAs) – If a plan is set up as a QACA with certain minimum levels of employee and employer contributions, it is exempt from the annual IRS testing requirement that a traditional 401(k) plan must pass. The initial automatic employee contribution must be at least 3 percent of compensation. Contributions may have to automatically increase so that, by the fifth year, the automatic employee contribution is at least 6 percent of compensation.

The automatic employee contributions cannot exceed 10 percent of compensation in any year. The employee is permitted to change the amount of his or her employee contributions or choose not to contribute but must do so by making an affirmative election.

The employer must make at least either:

  • A matching contribution of 100 percent for salary deferrals up to 1 percent of compensation and a 50 percent match for all salary deferrals above 1 percent but no more than 6 percent of compensation; or
  • A nonelective contribution of 3 percent of compensation to all participants

In a QACA, the employer may make an additional contribution to each employee’s account and have the flexibility to change the amount of these additional contributions each year, according to business conditions.

Contribution Limits – Employer and employee contributions to an automatic enrollment 401(k) plan are subject to an overall annual limitation for each employee. Employer and employee contributions and forfeitures (nonvested employer contributions of terminated participants) may not exceed the lesser of:

  • 100 percent of the employee’s compensation, or
  • $49,000 per year for 2009 and 2010.

Employees can make salary deferrals of up to $16,500 per year for 2009 and 2010. This includes both pre-tax employee salary deferrals and after-tax designated Roth contributions (if permitted under the plan).

Like any other 401(k) plan, an automatic enrollment 401(k) plan can allow catch-up contributions of $5,500 per year for 2009 and 2010 for employees aged 50 and over.


Automatic employee contributions, like all salary deferrals, are immediately 100 percent vested — that is, the money that an employee has contributed to the plan cannot be forfeited. When an employee leaves employment, he/she is entitled to those deferrals, plus any investment gains (or minus losses) on his/her deferrals.

Employer contributions are vested according to the plan’s vesting schedule. However, the required employer contributions under a QACA must be fully vested by the time an employee has completed two years of service.


In order to preserve the tax benefits of a 401(k) plan, the plan must provide benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare plan participation and contributions of rank-and-file employees to owners/managers.

Basic automatic enrollment 401(k) plans and most EACAs are subject to annual testing to assure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. Keep in mind, automatic enrollment increases participation, thereby making it more likely that a plan will pass the test. Automatic enrollment 401(k) plans set up as QACAs are not subject to this annual testing.

Investing the Contributions

Employers interested in automatically enrolling employees in a 401(k) plan previously worried about potential liability for losses resulting from their investment choices when participants did not provide direction. They were also concerned about deducting employees’ contributions from their paychecks without prior approval. The good news is that changes in the law address both issues and make automatic enrollment 401(k) plans an attractive option.

Now you can automatically invest employee contributions in certain default investments that generally offer high rates of return over the long term and provide a greater opportunity for employees to save enough money to take them through retirement. If carried out properly, you can limit your liability as plan fiduciary for any automatic enrollment 401(k) plan losses that are a result of investing participants’ contributions in these default investments. Note that you still are responsible for prudently selecting and closely monitoring these default investments. (See Fiduciary Responsibilities for more information.)

There are conditions to obtain this relief from liability:

  • Plan sponsors place the participant’s contributions in certain types of investments (discussed below).
  • Before his or her first contribution is deposited, the participant receives a notice describing the automatic enrollment process (discussed below); a similar notice is sent annually thereafter.
  • The participant does not provide investment direction.
  • The plan passes along to the participant material related to the investment, such as prospectuses.
  • The participant is given the opportunity periodically to direct his or her investments from the default investment to a broad range of other options.

Qualified Default Investment Alternatives – As noted in the first condition listed above, there are certain criteria for the default investments. You can choose from four types of investment alternatives for employees’ automatic contributions, called qualified default investment alternatives, or QDIAs. Three alternatives are diversified to minimize the risk of large losses and provide long-term growth. They are:

  • A product with an investment mix that changes asset allocation and risk based on the employee’s age, projected retirement date, or life expectancy (for example, a lifecycle fund);
  • A product with an investment mix that takes into account a group of employees as a whole (for example, a balanced fund); and
  • An investment management service that spreads contributions among plan options to provide an asset mix that takes into account the individual’s age, projected retirement date, or life expectancy (for example, a professionally managed account).

These alternatives can include products offered through variable annuity contracts and other pooled investment funds.

There is an alternative that allows plans to invest in capital preservation products, such as money market or stable value funds, but only for the first 120 days after the participant’s first automatic contribution. This option can be used only in EACAs that permit employees to withdraw their automatic contributions and earnings between 30 and 90 days (as specified in the plan) after the participant’s first automatic contribution. Before the end of the 120-day period, if you receive no direction, you must redirect the participant’s contributions in the capital preservation product to one of the long-term investments mentioned above.

When selecting products to use as default investments, remember that they generally cannot hold employer securities (such as employer stock).

Note that you do not have to select a QDIA for your plan. You may find that other default investment alternatives would be more appropriate for your employees.

Notifying the Employees – Under another condition for the liability relief, you must provide employees notice in advance of the first investment of automatic employee contributions and annually thereafter, so they can make informed decisions regarding participating and investing in the plan. For information on the timeframes for providing the notices, see Disclosing Plan Information to Participants.

The notice should include information about the automatic contribution process, including the opportunity to elect out of the plan. In addition, the notice must describe the default investment the plan is using, the participants’ right to change investments, and where to obtain information about other investments offered by the plan. To help in preparing your notice, a sample notice is available on both the DOL and IRS Web sites under “Pension Protection Act.”

If the participant, after receiving the initial or annual notice, does not provide investment direction, the participant is considered to have decided to remain in a default investment.

Transferring or Withdrawing Investments from a Default Investment – Employees may not want to participate in the company retirement plan, or they may decide to direct their plan investments themselves rather than have their contributions invested on their behalf. Participants whose contributions are automatically deposited in the default investment must be allowed to change their investments to other available plan options as frequently as participants who actively chose the default investment, and at least once every quarter. If you want to allow participants to withdraw their contributions within 30 to 90 days of the first contribution, your plan document must provide for this and be set up as an EACA.

If an employee decides to withdraw investments within 30 to 90 days of the first contribution or to change investments, a plan cannot impose restrictions, fees, or expenses beyond standard fees for services such as investment management and account maintenance. Further, participants should not be subject to penalties such as surrender charges, liquidation fees, or market value adjustments.

All participants in the plan must be offered an opportunity to diversify their portfolios with a broad range of other options in addition to the default investments. You can limit your liability for the participants’ investment decisions if you set up your plan properly. (See Limiting Liability for more information.)