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When a 401(k) plan includes an automatic enrollment feature, eligible employees must be automatically enrolled at a preset contribution rate unless the employee elects a different rate. The SECURE 2.0 Act of 2022 (SECURE 2.0) requires new 401(k) plans established on or after December 29, 2022 to implement an automatic enrollment feature in 2025 unless an exception applies. Employers must know whether the SECURE 2.0 mandate applies to their 401(k) plan, and if so, how to implement and administer a compliant automatic enrollment feature properly in 2025. Otherwise, a costly correction could become necessary.
This trouble is easy to avoid. Here’s what employers need to know.
Automatic Enrollment Basics
Automatic enrollment 401(k) plans are designed to simplify participation and increase retirement savings rates among employees. Key features of an automatic enrollment 401(k) plan include:
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- Default contribution rate – the plan must specify the contribution rate to be deducted from employee wages. Some plans include an “escalator” that increases the initial rate annually until a cap is reached.
- Default investment option - Automatic contributions must be invested in the plan’s default investment option unless the employee directs otherwise.
- Opt-out provision - Automatic enrollment does not mean mandatory enrollment. An employee can opt out by electing a zero percent (0%) contribution rate.
- Participant disclosure – Employers must distribute information about the automatic enrollment feature to employees, including details about contribution rates, investment options, and how to opt out.
401(k) Plans Subject to Mandatory Automatic Enrollment
SECURE 2.0 was enacted on December 29, 2022. 401(k) plans “established” on or after the date are considered post-enactment plans, while plans established before the date are considered pre-enactment plans. Only post-enactment plans are subject to SECURE 2.0’s automatic enrollment mandate unless a new or small business exemption applies. Notice 2024-02 defines “established” as the initial adoption date of the plan’s wage deferral feature, even if the plan’s effective date is later.
For example, a 401(k) plan with a January 1, 2023 effective date would not be subject to the mandate if adopted prior to December 29, 2022. In contrast, a profit sharing only plan that converts to a 401(k) plan on or after December 29, 2022 would be, regardless of the age of the plan.
401(k) plans established by new businesses in existence for less than 3 years and small businesses with fewer than ten employees are exempt from SECURE 2.0’s automatic enrollment mandate.
Automatic Enrollment Requirements for New 401(k) Plans
New 401(k) plans subject to the SECURE 2.0 mandate must implement a qualifying automatic enrollment feature no later than the first day of the plan year beginning after December 31, 2024 (January 1, 2025 for a calendar-based plan). The same default rate requirements apply to starter, traditional, and safe harbor 401(k) plans:
- Initial default rate - Must be between 3% and 10% of compensation.
- Rate escalation - Not necessary if the initial rate is 10%. Otherwise, the rate must increase at least 1% annually to no less than 10% (15% maximum).
How Plan Mergers and Spinoffs Affect the Mandate
Notice 2024-02 includes guidance about how mergers and spinoffs will affect the pre- or post-enactment status of a plan.
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- Merging two pre-enactment plans - the surviving plan will continue to be treated as a pre-enactment 401(k) plan.
- Merging pre- and post-enactment plans - the surviving plan will not be treated as a pre-enactment plan unless the merger meets specific requirements in which the pre-enactment plan is the surviving plan.
- Spin-off plan - if part of a pre-enactment plan is spun-off to create a new plan, the new plan will continue to be treated as a pre-enactment 401(k) plan.
Employers that join a pre-enactment Multiple-Employer Plan (MEP) or Pooled Employer Plan (PEP) after December 29, 2022 will be treated as adopting a post-enactment plan.
Automatic Enrollment Mistakes Can Be Costly!
The consequences can be significant for employers who don’t comply with SECURE 2.0’s automatic enrollment mandate timely. Revenue Procedure 2021-30 sets forth a safe harbor method for correcting reasonable errors to automatically enroll or escalate employees. In general, it involves the employer allocating a corrective contribution to affected employees. The contribution amount could be steep if the employer improperly excluded a lot of employees for an extended period of time.
Given the high stakes involved, employers should be proactive in working with their plan provider to implement the required changes.
