FLASHPOINT: Mandatory Automatic Enrollment:
Be Our Guess!

By Ilene H. Ferenczy and S. Derrin Watson

Well, it’s late December and Treasury and the IRS have yet to issue guidance on the new Mandatory Automatic Enrollment (“MAE”) rules that are effective as of January 1, 2025.  (For those who are living under an ERISA rock, most 401(k) and 403(b) plans must institute automatic enrollment for their employees beginning in 2025.) 

What happens when there is no guidance?  Everyone must use their best good faith interpretation of the rules in relation to the open questions affecting our clients.

In truth, no one (except the select few at Treasury) knows what the regulations will ultimately say about the various items yet to be elucidated.  However, we thought we’d share our best guesses based on our collective … ahem! … 80+ years of ERISA experience.

Remember that there are plans that are exempted from MAE:  plans signed before the enactment of SECURE 2.0 (“grandfathered plans”); plans sponsored by new companies (i.e., fewer than three years old) or small companies (more about them later); government and church plans, and SIMPLE plans.  Our discussion below (except where specifically referenced) is about the plans that are not exempt.

Will the effective date be pushed back?

Our guess:  no. 

Treasury representative Kevin Brown said at the ASPPA Annual conference this year that the MAE train has been coming into the station since December 2022, so we have had time to prepare.  Further, unlike the Roth Catch-up rules that were delayed, which did not provide any extra benefit to employees, MAE means that there are some employees who will have retirement money that they would not otherwise have elected to have.  On the whole, we believe it is very unlikely that the January 1, 2025, effective date will be extended.

Given the absence of guidance, will the IRS be satisfied with a reasonable, good faith interpretation of the law for 2025?

Our guess:  Probably, yes.  We certainly hope so!

Without more information, all we can do is what we think is correct.  Of course, the problem is that one’s concept of what is a reasonable interpretation may differ from an IRS auditor’s!

Does everyone in an existing plan have to be automatically enrolled?

Our guess:  no.  But the real question is the one that comes next:  who can we permissibly exclude?  So, our full guess:  no, but with limited permissible exclusions.  To show how difficult this issue is, we must admit that we do not agree among ourselves what those permissible exclusions are!

The law requires that the MAE structure be an eligible automatic contribution arrangement or EACA.  The EACA rules, both in the Code, and in the government guidance, are not crystal clear.  An EACA is defined in Code section 414(w) to be an automatic contribution arrangement under which:

• A participant may elect to have salary deferrals made on their own behalf;
• In absence of an affirmative election, the participant is deemed to have made an election to have salary deferrals made on his or her behalf under a “uniform percentage of compensation provided under the plan”; and
• Notice requirements are met.

The regulations to Section 414(w) provide additional guidance.  Specifically, the “uniform” percentage may vary as it does in a QACA (i.e., different rates for different years of service or participation, as required under the MAE rules), and different “disaggregation groups” can be treated differently.  Two common disaggregation groups are (i) union vs. nonunion and (ii) “normal participants”, i.e., those who the plan permits to enter before they have completed one year of service and attained age 21.

The regulations also define a “covered employee,” as one who must be subject to the automatic enrollment, as provided in the plan.  In Notice 2009-65, the IRS gave us sample amendment language for EACAs, permitting the definition of “covered employee” to include (i) all participants; (ii) participants who do not have an affirmative election in place; or (iii) participants who enter the plan after the effective date of the automatic enrollment arrangement.  The IRS has since repeated this language in the sample provisions it has published each restatement period for preapproved plans.  Note that the employer must use definition (i) above to be able to take advantage of the extended six-month deadline to correct for ADP/ACP testing failures without incurring an excise tax.

But, are those the only permissible exclusions from an EACA?  Or, can we exclude other groups of employees from MAE, like those hired before the MAE effective date, even if we adopt the plan after that date (as one of our TPA clients encouraged us to approve)?  Or, can we exclude Long-Term Part-Time (“LTPT”) employees from MAE?  Notwithstanding the above quoted language, there are pre-SECURE 2.0 EACAs in existence with other exclusions, such as limiting automatic enrollment to employees hired after a specific date. 

Ilene’s safest guess is that only the exclusions permitted will be two discussed above:  those with affirmative elections and those who participate before the effective date of the MAE provision.  Derrin is even more conservative on this issue, and thinks the IRS will require automatic enrollment of all participants, except those with existing affirmative elections.  Both of us are betting that there is no LTPT exclusion from MAE.

You and your clients may choose a more aggressive stance.  However, keep in mind that, if the ultimate regulations find that other exclusions are not permitted, you may have a “failure to implement a deferral election,” which may require that the employer make QNECs (and related matches) for those excluded from the automatic enrollment.  So, take your chances, but understand the potential ramifications.

Can we continue to have EACAs without participant direction of investments?

Our guess:  maybe not, unless the government decides to provide relief.

SECURE 2.0 requires that plans with MAE have a QDIA for participants’ accounts in absence of affirmative investment elections.  This clearly assumes that all 401(k) and 403(b) plans in existence have participant-directed investments.  But what if that assumption is faulty, and there’s a 401(k) plan for which all accounts are pooled for investment purposes?

This is a tough one, because the requirement is in the law, not just IRS rules.  Our best guess is that the plan must maintain a QDIA, and participants in a pooled-investment plan must be given a choice between the QDIA and the pooled investments.  That is, full ERISA 404(c) participant direction is not required.  But this seemingly simply answer is fraught with other problems because of notice requirements.  In short:  will this limited level of participant choice trigger all the required participant disclosures and notices associated with participant direction, including the comparative chart of investments of Labor Regulation 2550.404a-5?  If it does, than it is practically impossible for a pooled investment plan to comply.

What are the odds that the IRS and DOL modify the disclosure rules to treat pooled investment plans differently?  We don’t know …. We’re lawyers, not bookmakers!  But, we can hope.

Are pre-SECURE 2.0 single employer plans that merge into post-2022 MEPs and PEPs grandfathered?

Our guess:  no.

We say that with great disappointment, as we believe it is the wrong approach for the IRS to take.  Our guess is based on Kevin Brown’s warning at the ASPPA conference that many of us would be unhappy with what the MAE regulations ultimately say.

Guidance issued to date [Notice 2024-2] gave us the answer to all of the into-the-MEP/PEP and out-of-the-MEP/PEP situations except this one.  We had hoped initially that it was just an oversight and that the IRS would ultimately follow the lead it sets with the other situations:  the history of the individual employer and its previous plan would control what happens in the MEP/PEP.  However, Kevin’s warning has made us a little less optimistic.

We, and we assume the IRS, know that this is a huge disincentive for existing plans to merge into a new multiple employer plan arrangement.  It may also be indicative that the government is trying to encourage employers and their service providers to just accept the inevitability of MAE.

What does “normally employs fewer than 11 employees” mean?

Our guess:  facts and circumstances, baby!

This is one of the exclusions from MAE – i.e., the “small business” exclusion.  But no one knows what it means.

We think that the only way to really judge this is under the facts and circumstances:  i.e., does the company generally employ at least 11 people?  A fact like “we had a really busy January and had to hire a temporary employee” would not be “normally employs.”  However, once you are hiring your 11^th person with the expectation that they are filling a permanent position, this appears to us to require MAE.  Remember that the law gives you until 1 year following the close of the first taxable year in which the company employs more than 10 people.  For example, if a company hired its 11^th person on August 1, 2024, and the company files its taxes on the calendar year, MAE would apply as of January 1, 2026.

So, if the company is doing a little hokey-pokey with that 11^th employment position, there may be some wiggle room.

Remember that the 11-person count refers to employees, not participants.  Part-time employees count.  Perhaps seasonal employees do not, we’re not sure.  It’s an open issue as to whether a self-employed individual (i.e., sole proprietor or partner) is included in the employee count.  There’s also a question about whether the controlled group and affiliated service group rules apply for the purpose of counting employees (we are betting they do, but the law does not say so).

If a tax-exempt organization sponsors a deferral-only 403(b) plan that is not subject to ERISA, does MAE apply?

Our guess:  yes.

While governmental and church plans are exempted from MAE under the law, there is no other exception that would apply to deferral-only 403(b) plans.  MAE is a Code or tax obligation, not an ERISA rule.  So, whether the plan is subject to ERISA is likely beside the point.

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When the regulation or other guidance is finally issued, we’ll report back on how well we guessed.  In the meantime, best wishes from all of us to you for a happy, healthy, and prosperous New Year!

And, remember, when you need us, we are your 2025 ERISA Solution!