Management / Small Business

Small Business Guide to Automatic Enrollment 401k Plans

Fiduciary Responsibilities

In addition to selecting and monitoring the default investments for automatic employee contributions, many of the other actions needed to operate an automatic enrollment 401(k) plan involve fiduciary decisions. This is true whether you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you or the entity you hire a plan fiduciary to the extent of that discretion or control. Thus, fiduciary status is based on the functions performed for the plan, not a title. Be aware that hiring someone to perform fiduciary functions is itself a fiduciary act.

Some decisions with respect to a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, are acting as fiduciaries.

Basic Responsibilities – Those persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities include:

  • Acting solely in the interest of the participants and their beneficiaries;
  • Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
  • Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters;
  • Following the plan documents;
  • Diversifying plan investments.

These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. And, since all these functions must be carried out in the same manner as a prudent person would, it may be in your best interest to consult experts in various fields, such as investments and accounting.

In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees’ paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter timeframe, you need to make the deposits at that time.

Limiting Liability – With these responsibilities, there is also some potential liability. However, there are actions you can take to demonstrate that you carried out your responsibilities properly as well as ways to limit your liability.

The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the end results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a “winner” if it was part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary needs to carry out activities through a prudent process, you should document the decisionmaking process to demonstrate the rationale behind the decision at the time it was made.

In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to limit your liability for participants’ investment decisions when they exercise control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.

Hiring a Service Provider – Even if you do hire a financial institution or retirement plan professional to manage the whole plan, you retain some fiduciary responsibility for the decision to select and keep that person or entity as the plan’s service provider. Thus, you should document your selection process and monitor the services provided to determine if a change needs to be made.

Some items to consider in selecting a plan service provider:

  • Information about the firm itself: affiliations, financial condition, experience with 401(k) plans, and assets under their control;
  • A description of business practices: how plan assets will be invested if the firm will manage plan investments or how participant investment directions will be handled, and proposed fee structure;
  • Information about the quality of prospective providers: the identity, experience, and qualifications of the professionals who will be handling the plan’s account; any recent litigation or enforcement action that has been taken against the firm; the firm’s experience or performance record; if the firm plans to work with any of its affiliates in handling the plan’s account; and whether the firm has fiduciary liability insurance.

Once hired, these are additional actions to take when monitoring a service provider:

  • Review the service provider’s performance;
  • Read any reports they provide;
  • Check actual fees charged;
  • Ask about policies and practices (such as trading, investment turnover, and proxy voting); and
  • Follow up on participant complaints.

Prohibited Transactions and Exemptions – There are certain transactions that are prohibited under the law to prevent dealings with parties that have certain connections to the plan, self-dealing, or conflicts of interest that could harm the plan. However, there are a number of exceptions under the law, and additional exemptions may be granted by the U.S. Department of Labor, where protections for the plan are in place in conducting the transactions.

One exemption allows the provision of investment advice to participants who direct the investments in their accounts. This applies to the buying, selling, or holding of an investment related to the advice as well as to the receipt of related fees and other compensation by a fiduciary adviser. Please check for more information.

Another important exemption permits you to offer loans to participants through your plan. If you do, the loan program must be carried out in such a way that the plan and all other participants are protected. Thus, the decision with respect to each loan request is treated as a plan investment and considered accordingly.

Bonding – Finally, persons handling plan funds or other plan property generally must be covered by a fidelity bond to protect the plan against losses resulting from fraud and dishonesty by those covered by the bond.

Disclosing Plan Information to Participants

Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plan’s structure and operations, and provide them a chance to make decisions and take timely action with respect to their accounts.

The automatic enrollment notice details the plan’s automatic enrollment process and participant rights. The notice must specify the deferral percentage, the participant’s right to change that percentage or not to make automatic contributions, and the default investment.

The notice for EACAs and QACAs is similar to that discussed under Notifying the Employees but does contain some additional required information. To help in preparing your notice, a sample notice (for EACAs, QACAs, and QDIAs) is available on both the DOL and IRS Web sites under “Pension Protection Act.”

The participant generally must receive the initial notice at least 30 days, but not more than 90 days, before eligibility to participate in the plan or the first investment. Subject to certain conditions, the notice may be provided, and an employee may be enrolled in the plan, on the first day of work.

An annual notice must be provided to participants and all eligible employees at least 30 days, but not more than 90 days, prior to the beginning of each subsequent plan year.

The summary plan description (SPD) – the basic descriptive document – is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the features and what to expect of the plan. Among other things, the SPD must include information about:

  • When and how employees become eligible to participate in the 401(k) plan;
  • The contributions to the plan;
  • How long it takes to become vested;
  • When employees are eligible to receive their benefits;
  • How to file a claim for those benefits; and
  • Basic rights and responsibilities participants have under the Federal retirement law, the Employee Retirement Income Security Act (ERISA).

This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

summary of material modification (SMM) apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change.

An individual benefit statement (IBS) shows the total plan benefits earned by a participant, vested benefits, the value of each investment in the account, information describing the ability to direct investments, and an explanation of the importance of a diversified portfolio. Plans that provide for participant-directed accounts must furnish individual account statements on a quarterly basis. In addition, the IBS must be provided when a participant submits a written request, but no more than once in a 12-month period, and automatically to certain participants who have terminated service with the employer.

summary annual report (SAR) is a narrative of the plan’s annual return/report, the Form 5500, filed with the Federal government.  (See Reporting to Government Agencies for more information.)  It must be furnished annually to participants.

Reporting to Government Agencies

In addition to the disclosure documents that provide information to participants, plans must also report certain information to government entities.

Form 5500, Annual Return/Report of Employee Benefit Plans – Automatic enrollment 401(k) plans are required to file an annual return/report with the Federal government, on which information about the plan and its operation is disclosed to the IRS and the U.S. Department of Labor. Beginning with the reports for 2009, plans that must file the Form 5500 must do so electronically. These disclosures are made available to the public.

Depending on the number and type of participants covered, most automatic enrollment 401(k) plans must file one of the following forms:

  • Form 5500, Annual Return/Report of Employee Benefit Plan,
  • Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan, or
  • Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan

Most one-participant plans (sole proprietor/spouse and certain partnership plans) with total assets of $250,000 or less are exempt from the annual filing requirement. However, regardless of the value of the plan’s assets, a final return/report must be filed when a plan is terminated.

Form 1099-R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., is given to both the IRS and recipients of distributions from the plan during the year. It is used to report distributions (including rollovers) from a retirement plan.

Permissible Withdrawals of Automatic Contributions – If an eligible automatic enrollment 401(k) plan (EACA) has opted to allow employees to withdraw their automatic contributions within 90 days of the first contribution, then those amounts, distributed with earnings, are treated as taxable income in the year distributed. They are reported on Form 1099-R and are not subject to the 10 percent additional early withdrawal tax.

Distributing Plan Benefits

Benefits in an automatic enrollment 401(k) plan are dependent on a participant’s account balance at the time of distribution.

When participants are eligible to receive a distribution, they typically can elect to:

  • Take a lump sum distribution of their account;
  • Roll over their account to an IRA or another employer’s retirement plan; or
  • Purchase an annuity.

Terminating An Automatic Enrollment 401(k) Plan

Automatic enrollment 401(k) plans must be established with the intention of being continued indefinitely. However, business needs sometimes require that an employer terminate its plan.

Typically, the process of terminating an automatic enrollment 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You should also notify your employees that the plan will be discontinued. Check with your plan’s financial institution or a retirement plan professional to see what further action is necessary to terminate your automatic enrollment 401(k) plan.


Even with the best intentions, mistakes in plan operation can still happen. The U.S. Department of Labor and IRS have correction programs to help automatic enrollment 401(k) plan sponsors correct plan errors, protect participants and keep the plan’s tax benefits. These programs are structured to encourage early correction of the errors. Having an ongoing review program makes it easier to spot and correct mistakes in plan operations.

An Automatic Enrollment 401(k) Plan Checklist

Now that you are ready to get started, here are some tips:

  1. Have you adopted a written 401(k) plan that provides for automatic enrollment?
  2. Have you decided to hire a financial institution or retirement plan professional to help you set up and run the plan?
  3. Have you decided upon the percentage of compensation for the automatic employee contributions? Have you considered the level of employer contributions, whether optional or required?
  4. Have you decided to set up your plan as an EACA and/or a QACA?
  5. In selecting a default investment, have you decided to meet the conditions for fiduciary liability relief for this investment?
  6. Have you developed a recordkeeping system that includes tracking employee elections for those opting out of the plan and for those employees who elect a different percentage?
  7. Have you provided or are you prepared to provide the initial notice to employees in advance of their first automatic contributions? And are you prepared to satisfy the annual notice requirements?
  8. Are you familiar with the fiduciary responsibilities of sponsoring an automatic enrollment 401(k) plan?
  9. Are you prepared to monitor the plan’s service providers and investments?
  10. Are you familiar with the reporting and disclosure requirements of an automatic enrollment 401(k) plan?

Creating an automatic enrollment 401k plan for your employees will increase participation and help them save money for retirement. This small business guide taught you how to setup a small business automatic enrollment 401k plan.