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Testimony Before the Internal Revenue Service on Automatic Contribution Arrangements
Frank Nessel of Vanguard On Behalf of the Investment Company Institute
May 19, 2008
Good morning. My name is Frank Nessel, and I am testifying on behalf of the Investment Company Institute, the national association of U.S. investment companies, including mutual funds. Because mutual funds comprise 55 percent of 401(k) plan assets today and because many mutual fund organizations provide administrative and recordkeeping services to plans, Institute members have a significant interest in workable and cost-effective regulations for retirement savings for our country’s workforce. I have worked with qualified plans for more than 25 years, currently as a Senior Consultant in Vanguard’s Plan Consulting Group. The Vanguard Plan Consulting Group is a diverse team of attorneys, consultants, actuaries, and benefits specialists that provide consulting services to plans with respect to ERISA and Code compliance. Vanguard has had a significant number of its clients adopt automatic enrollment plans over the last four or five years, and our Plan Consulting Group has assisted many of these plan sponsors in implementing these arrangements.
The Institute and its members urge the Service to modify its proposed regulation in several respects in order to encourage—rather than discourage—employers of all sizes to implement automatic enrollment arrangements.
Today, I’d like to cover three topics.
First, I will talk about why the Service should permit plans to implement eligible automatic contribution arrangements (or EACAs) any time during a plan year.
Second, I will address why the Service should allow plans flexibility in how to treat existing employees when adding an EACA.
Finally, I will suggest several technical clarifications to address operational and compliance issues that face employers and service providers in implementing automatic contribution arrangements.
I will begin with the issue of whether, as the Service proposed, plans should only be permitted to implement EACAs at the beginning of a plan year. The Institute (and many other commenters) strongly believes that mid-year EACAs both are permitted by the Code and consistent with Congress’ intent to encourage automatic enrollment. We understand the Service proposed the full plan year requirement primarily for two reasons. First, the Service inferred a full plan year requirement from the Code requirement that EACA participants must receive an annual EACA notice. Second, the Service was concerned that employers that implement EACAs at mid-year would receive the benefit, available to plans with EACAs, of a 3½ month extension for distributions of excess contributions. As we described in our comment letter, we do not believe the Service made the correct statutory inference, or that employers will set up EACAs mid-year solely to get a mere 3½ months extension. Most importantly, the Service’s interpretation would run contrary to Congress’ intent in encouraging retirement savings through automatic enrollment.
Requiring an employer to implement an EACA only at the beginning of a plan year would delay participation in retirement plans by scores of employees who could begin accumulating their retirement savings mid-year. Academic research consistently shows that automatic enrollment increases participation rates in retirement plans, especially for low-income workers. In many plans, once employees begin participating in a plan, they may become eligible for employer contributions, and all these savings enjoy the benefit of compounding over time.
There are significant practical implications to limiting auto-enrollment to the beginning of a plan year. I can tell you that requiring plans to implement EACAs at the beginning of the plan year will create long queues of plans waiting to set up EACAs, because almost 90 percent of 401(k) plans are calendar- year plans. Based on Vanguard’s experience, it takes about three months to implement auto-enrollment. Some work is done by us, the recordkeeper, but a lot of work must be done by the plan sponsor (such as changing payroll data), and employers have a multitude of other issues to deal with at the end of a calendar year, including open enrollment and other benefits-related issues. Based on simple economics, small plans most likely will end up at the end of the recordkeeper’s queue. Given that almost 90 percent of defined contribution plans have fewer than 100 participants, the impact on small plans will be significant. I can also tell you from my personal experience that some employers, if they cannot implement an EACA at the time they are considering it, may never implement them because their focus may shift to other more pressing issues later in the year. The result is a lost opportunity for enhancing employee savings and retirement security.
We believe that these concerns far outweigh any possible risk that employers will “game” the rules to obtain an extension for distributing excess contributions. First, we believe it is unlikely that employers will time EACA implementation just to get the 3½ -month extension. Second, a delayed implementation date is a one-time benefit. Once an EACA is implemented, it will continue for full plan years. For all these reasons, we urge the Service to allow mid-year EACAs in the final regulation.
My second point is that automatic enrollment should not be required for employees who were hired prior to the date that the EACA features were added to the plan. We believe that the automatic enrollment requirements for an EACA should be distinguished from those imposed on a QACA, which is subject to the provisions of Code section 401(k)(13). This section requires all non-participating employees who have not made an affirmative election to be “swept” into the plan at the minimum deferral rate. An EACA is not subject to the requirements of Code section 401(k)(13). Accordingly, we strongly urge the Service to exclude existing employees in newly adopted EACAs from the automatic enrollment “sweep” requirements.
Finally, I would like to address a number of issues the Service should clarify in the final regulation, with the goal of providing flexibility in the design of the auto-enrollment feature and eliminating complexity that would deter employers (especially smaller employers) from implementing auto-enrollment.
The Service should clarify the notice timing requirements for EACAs and QACAs in plans with immediate eligibility. As proposed, initial notices would have to be provided to new hires on the first day of employment. Having worked with plans for more than 25 years, I know it is not realistic to expect employers to always be able to satisfy this requirement. We believe it would be as effective and protective of a new hire’s rights to provide the notice as soon as practicable on or after the employee becomes an eligible employee, provided the new hire has a reasonable opportunity to elect out of the arrangement prior to the first contribution being taken out of his or her paycheck.
As proposed, the required content requirements for EACA notices may be too detailed to be effective. The notice should tell the participant how much he or she will contribute in the absence of an election, how these funds will be invested, and what the participant needs to do to opt out. Any additional information may detract from this important information. We recommend that the final regulation permit employers to cross-reference other plan documents for more detailed plan rules (e.g., the so-called mini-SPD content), and to allow employers who know their work forces to decide what other information to include in the notice beyond the minimum requirements.
With respect to QACA and EACA investment elections, the final regulation should clarify that a participant should still be treated as an EACA or a QACA participant when he or she changes his or her investment election but does not change the deferral rate from the EACA or QACA deferral rate. We believe this is the right result because automatic enrollment under the Code refers to the deferral percentage, and not to investment elections.
We recommend that rehires be treated as new employees for purposes of the automatic enrollment provisions of an EACA or QACA, even if the rehire date occurs during the same plan year as the termination date. This will eliminate the need for recordkeepers to track the deferral percentages of former participants who were automatically enrolled in an EACA or QACA. To require the tracking of prior automatic contribution percentages would make administration of EACAs and QACAs much more complex and would likely result in errors in the administration of these arrangements.
We also request clarification that a QACA is available for a plan that permits immediate eligibility for employee deferrals but imposes up to a one-year eligibility requirement for employer matching contributions. The ability to disaggregate the portion of the plan benefiting those with less than one year of service has been a permissible feature for safe harbor 401(k) plans since the issuance of Notice 98-52. We believe that this same rationale should apply if a 401(k) plan satisfies the safe harbor requirements by means of a QACA.
Finally, the Service should modify the rule for determining when the 90-day election period begins, for purposes of the permissive withdrawal feature of Code section 414(w). Under the Code, this period begins with the date of the first EACA contribution. Under the proposal, the date of the EACA contribution is the date the contribution would otherwise have been included in the employee’s gross income. This definition will complicate the 90-day election process and make it more expensive to plans and participants. Service providers have information on when plan contributions are received and invested, but most providers would not have information on when the contribution was first considered income to participants. We believe the final regulation should allow providers to use the information they have instead of having to incur the costs and burdens of developing new processes and procedures. The parallel Department of Labor regulation allows providers to use the date of first investment in calculating the 90-day period, and we support this result.
Thank you for your time. I would be happy to answer any questions.