PPA Preempts State Wage Laws to Encourage Automatic Employee Deferrals
Lawrence Jenab, Friday, September 01, 2006 | Filed under: 401(k) Plans, Legislation, Plan Investments
Under an automatic enrollment feature, employees accumulate retirement savings through payroll deduction by default – unless they make an affirmative election to opt out of the program. For the past several years, in keeping with the federal government’s efforts to shore up the nation’s retirement savings, government agencies have actively encouraged such arrangements under employer-sponsored defined contribution plans. For example, under the auspices of ERISA’s preemption provision, the Department of Labor (“DOL”) has consistently opined that retirement plan sponsors are free to implement automatic employee deferral features, regardless of state wage laws to the contrary. And the Internal Revenue Service (“IRS”) has long blessed automatic enrollment – including in final regulations issued under Section 401(k) of the Tax Code. But some employers have hesitated to implement automatic enrollment, in part because several states (despite ERISA’s preemption provisions and the DOL’s pronouncements) have taken the position that their wage payment laws prohibit the withholding of any portion of an employee’s pay without an affirmative election by the employee. The Pension Protection Act of 2006 (the “Act” or “PPA”) eliminates this obstacle to automatic enrollment, at least under deferral plans that are subject to ERISA.
The PPA amends ERISA’s preemption provisions to expressly supersede any state law that “would directly or indirectly prohibit or restrict” an automatic enrollment feature. The Act specifies notice and default investment requirements that must be satisfied in order to take advantage of this preemption provision. Unlike most other PPA provisions, however, this preemption provision became effective upon the law’s enactment. Any interested plan sponsor is therefore free to implement an automatic enrollment feature at any time.
BENEFITS OF AUTOMATIC ENROLLMENT FEATURE
The most obvious benefit of automatic enrollment accrues to the individual employee, who gains from both the forced savings and the favorable tax treatment accorded elective contributions. But automatic enrollment may also provide a boon to certain employees who are already making significant elective deferrals.
Under the Tax Code’s nondiscrimination rules (specifically, the ADP test), low deferral rates by non-highly compensated employees create a ceiling on deferral rates for highly compensated employees. By increasing deferral rates for non-highly compensated employees, an automatic enrollment feature may raise this ceiling on the amount that highly compensated employees may defer.
SAFE-HARBOR CONTRIBUTION OPTION
In still another effort to encourage the adoption of an automatic enrollment feature, the PPA provides a mechanism by which plans incorporating a new “safe- harbor” contribution formula may automatically satisfy the ADP/ACP tests, and also obtain an exemption from the top-heavy rules. While this new safe harbor is not available until 2008, plan sponsors may wish to begin laying the groundwork for it by implementing an automatic enrollment feature in 2007 (or even earlier).
MANAGING POTENTIAL FIDUCIARY LIABILITY
Employees who allow an automatic deferral election to remain in place are unlikely to make an affirmative investment election. It therefore falls to a plan’s fiduciaries to make these investment decisions for them. Yet current DOL regulations under ERISA Section 404(c) provide no protection to fiduciaries for investment losses attributable to such “default” investment options. This lack of Section 404(c) protection has caused some employers to delay adopting an automatic enrollment feature.
The PPA addresses this concern, as well – by instructing the DOL to issue regulations making the protections of Section 404(c) available to fiduciaries of plans containing an automatic enrollment feature. These regulations are to address appropriate mixes of default investments and asset classes. Although they will not be limited in scope to plans with automatic enrollment features, their protection for default investment options will be particularly helpful to such plans.
The Act directs the DOL to issue these regulations within six months of the PPA’s enactment (or by February 17, 2007). Because the statutory effective date of this change is somewhat earlier, however (January 1, 2007), we may see DOL regulations even before this six-month deadline arrives.