The ERISA Strategist
 April, 2000  
401(k) Plans

The focus of this issue of the ERISA Strategist is 401(k) plans.  We have set out three strategies designed to enhance the retirement savings of your employees.

1. Automatic Enrollment

Most employers are familiar with traditional 401(k) plan enrollment procedures, but probably few are aware of the "automatic enrollment" procedures approved by the Internal Revenue Service. Since automatic enrollment of employees in a 401(k) plan could increase employee participation and better prepare workers for retirement, an automatic enrollment feature certainly is worth considering.

Whereas traditional enrollment procedures require that employees initiate contributions by affirmatively deciding to contribute wages that are withheld from their pay, an automatic enrollment feature assumes that employees wish to contribute unless they "opt out" of the plan.  IRS Rulings 98-30 and 2000-8 provide that employers can automatically enroll new employees in the 401(k) plan if new employees are notified during orientation that, effective with their eligibility to participate (until superseded by a subsequent election), a set percentage of the employee's pre-tax wages will be automatically contributed to the 401(k) plan and placed in a mutual fund. If a particular employee prefers to receive cash in lieu of contributing to the plan, or if the employee wishes to contribute more or less income or invest in another available investment vehicle, then that employee may file an election form specifying the requested change(s). Automatic plan participants must be notified annually of the reductions made from their pay, and they must be notified of procedures for exercising their right to make changes to their elections.  Given adequate notice and a chance to elect their options, current employees also may be included in the automatic enrollment program.

While state laws may have an effect upon the availability of a 401(k) automatic enrollment feature and  must be considered before making changes to a 401(k) plan, the advantages of automatic enrollment are generating increased employer interest. The automatic enrollment feature is one change worth considering when you restate your plan this year.

2. Safe Harbor

For employers who want to avoid the costs associated with non-discrimination testing of their 401(k) plans, a non-discrimination safe harbor  is now available for elective and matching contributions.  Plans meeting certain design specifications will be treated by the Internal Revenue Service as meeting the non-discrimination tests.  Generally, the safe harbor can be met by making, on behalf on non-highly compensated employees, either ­

(i)  Fully vested matching contributions equal to 100% of the elective contributions of the non-highly compensated employee up to 3% of compensation, and 50% for contributions between 3% and 5% of compensation, with matching contribution percentages for highly compensated employees not exceeding those for non-highly compensated employees; or

 (ii)  Fully vested nonelective contributions to non-highly compen-sated employees in an amount at least equal to 3% of compensation.

Matching contributions cannot exceed 6% of the employee's compensation, and the matching or nonelective contributions are subject to the same distribution limitations as 401(k) deferrals.  Additionally, employers adopting a safe harbor contribution method are required to provide notice to employees of the safe harbor arrangement, normally within a reasonable period before the beginning of the plan year.  However, a plan sponsor that adopts a 401(k) safe harbor plan for the first time for a plan year that begins on or after January 1, 2000 and on or before June 1, 2000, may give this notice as late as May 1, 2000.

Many employers are finding that the elimination of non-discrimination testing by adopting a safe harbor plan is actually reducing their benefits costs.

3. Vacation Pay Rollovers

Companies with use-it-or-lose-it vacation policies should consider whether to provide employees with the option of turning the value of their accrued, but unused, vacation time into retirement savings.  If a company has, or changes to, a vacation policy which requires employees to forfeit unused vacation time, the company can allow employees to roll over the value of this time into their 401(k) or 403(b) Plan.  Employees will love this option because it provides them with an additional tax-free contribution to their Plan, the value of which they may otherwise have had to forfeit.  It is also an attractive option for companies because the election to roll over unused vacation pay to a 401(k) Plan amounts to a non-elective employer contribution and, therefore, companies are not required to pay payroll taxes on the benefit.

Another option can then allow an employee to elect to receive cash or to make a vacation pay rollover.  Where the employee retains the option of receiving cash for unused vacation time (a taxable benefit), any rollover into a savings plan would be treated as a salary deferral election.



If you have questions, or would like to have more information, please call Ira Friedrich or Carl Cannon at (404) 525-8622 in Atlanta, Dana Thrasher at (205) 252-9321 in Birmingham, or Rob Floyd at (703) 527-0900, Arlington.
 

The information in this publication is for the purpose of informing and educating our clients about various aspects of the law and is not intended to be used as legal advice.