Automatic contribution arrangements applicable to salary deferral plans (e.g., 401(k) and 403(b) plans) come in a variety of flavors. Like ice cream, the basic ingredients are the same, but the extra ingredients are what distinguish plain vanilla from rocky road. The parallel in 401(k) plans is that some plan sponsors are now required to offer rocky road, even if they only want vanilla. For the scoop on automatic enrollment options, we will include a sampling of the different flavors plan sponsors may select and will assist in determining if there is a choice between vanilla and rocky road.

In a nutshell, automatic enrollment means that when an employee starts a new job, they are automatically signed up to contribute to the company’s 401(k) plan unless they decide to opt out. A certain percentage of the employee’s paycheck is deducted automatically and invested in the plan without the employee having to do anything. These plans are designed to make saving for retirement easier and to encourage more people to start saving early. Employees can change the contribution amount or opt out entirely, but the default position is that the employee is automatically enrolled and contributing to the plan.

Before SECURE Act 2.0 was enacted, including automatic enrollment in the company’s 401(k) plan was a discretionary decision made by the plan sponsor. Effective for plan years beginning on or after January 1, 2025, SECURE Act 2.0 requires plans with salary deferral arrangements adopted after December 29, 2022 to include automatic enrollment provisions. Grandfathered 401(k) plans (in effect before December 29, 2022) are currently not required to include automatic enrollment but may choose to adopt these provisions to boost the participation rate of the employees covered by the plan.

Sounds easy enough, but each type of automatic contribution arrangement (aka automatic enrollment) has specific requirements, limitations and notice requirements. Furthermore, automatic enrollment provisions require significant coordination between the company’s payroll service and the plan’s recordkeeper to operate in compliance with the applicable regulations.

Mandatory or Optional?

401(k) plans that were in effect on or before the enactment of SECURE 2.0 on December 29, 2022 (pre-enactment plans) are grandfathered and are not required to adopt the mandatory automatic enrollment provisions. Small employers with less than ten (10) employees are not required to include the mandatory provisions until the plan year following the tax year the number of employees exceeds ten. And, new employers that have been in existence for less than three years are also exempt.

If only it were that easy to draw a line in the sand for which plans are required to include automatic enrollment versus still having the option to include or exclude those provisions. The “mandatory” piece is not as clear when there are business transactions that impact the 401(k) plan (i.e., mergers, acquisitions and spin-offs), nor when joining or leaving a Multiple Employer Plan (MEP) or Pooled Employer Plan (PEP).

In the case of a business transaction, when two plans are being merged within a certain transition period, the pre-enactment status of the surviving plan will determine if the plan is subject to mandatory automatic enrollment. For example, a 401(k) plan established in 2023 (post 12/29/2022) that is merged into a grandfathered plan (the surviving plan) will result in a grandfathered plan. However, if the grandfathered plan merged into the 2023 post-enactment plan, the surviving plan will be required to include mandatory automatic enrollment.

The same rules do not apply if single employer plans are voluntarily being merged (no business transaction). If either of the plans being merged is not grandfathered, then the result is the surviving plan is subject to the mandatory automatic enrollment provisions.

The status of a plan joining or leaving a MEP will be determined at the employer level, because a MEP is a plan that is sponsored by one or more unrelated employers. A simple way to keep track is to follow the assets. For example, take an employer that has sponsored a 401(k) plan since 2018, then joins a MEP/PEP in 2023 (assets merged into the MEP). In that situation, the employer’s portion of the MEP remains grandfathered. If that same employer spins out to a standalone plan in 2026, that plan is still grandfathered.

• Practice Note: If two 401(k) plans will be merging due to a business transaction, have the plan documents reviewed by legal counsel to determine which plan should be the surviving plan if one is grandfathered and the other is not.

Whether a plan is subject to the mandatory automatic enrollment provisions depends on many facts and circumstances, and the rules vary slightly depending on whether the plan is a 401(k) plan or a 403(b) plan. Proposed regulations were issued in January 2025 and provide additional details and guidance for compliance with the mandatory automatic enrollment requirements with the final regulations expected later in 2025.

The remainder of this discussion will focus on the different flavors of automatic enrollment.

Automatic Contribution Arrangements – The Basics

Traditional salary deferral elections are of the “opt in” variety, meaning that the employee must make an affirmative election to have deferrals deducted from their compensation, otherwise the default is zero withheld. Automatic contribution arrangements are the converse, whereby a default percentage will be withheld from an employee’s compensation as a deferral contribution unless the employee affirmatively “opts out” or makes a different deferral election. The move toward encouraging employers to implement automatic enrollment has increased over the last twenty years to encourage (or “nudge”) more employees to save for retirement.

Plans that include automatic enrollment must also include a Qualified Default Investment Alternative (QDIA). A QDIA is an investment option that is selected by a retirement plan sponsor to automatically invest the assets of participants who do not make an investment choice for their retirement savings. The QDIA is designed to help individuals who are defaulted into the plan (either by choice or due to inaction) receive an appropriate investment strategy. The goal of a QDIA is to provide participants with a well-diversified investment option that aligns with their long-term retirement goals. The most common QDIAs are:

• Target Date Funds: (TDFs): These are mutual funds designed for participants who plan to retire around a certain date. The fund's asset allocation adjusts over time, becoming more conservative as the participant approaches retirement.

• Lifecycle Funds: These are similar to target-date funds but are typically based on a series of time horizons. They allocate funds across different asset classes and gradually become more conservative as the target date nears.

• Managed Accounts: Some plans offer personalized investment management services that create a customized portfolio based on an individual’s retirement goals, risk tolerance, and time horizon.

• Balanced Funds: These funds offer a mix of stocks, bonds, and other investments. The allocation may be fixed or adjusted periodically, depending on the fund’s strategy.

QDIAs must offer diversification, be prudent, and be in the best interest of the participant. Additionally, the plan sponsor is required to provide participants with advance notice about the plan’s QDIA and to allow them to opt out of the QDIA or to change their investment allocation.

Types of Automatic Contribution Arrangements

• Automatic Contribution Arrangement (ACA): The plain vanilla version of automatic enrollment, in which a plan document includes provisions stating that a uniform default deferral percentage will apply to employees who do not opt out or make an affirmative election. ACAs may also include provisions for an automatic increase in the default deferral percentage the longer the employee works for the employer. A typical arrangement would default all newly eligible employees to a 3% deferral, then increase by 1% each year thereafter (which is typically capped at 10-15%). ACAs are not required to include the automatic increase, and many plans keep a static default rate that is tied to a matching contribution formula.

• Qualified Automatic Contribution Arrangement (QACA): The chocolate and vanilla swirl flavor of automatic enrollment, a QACA is a safe harbor 401(k) plan that includes automatic enrollment provisions. Key elements of a QACA:

  • Minimum default percentage must be at least 3% and cannot exceed 10%

  • Maximum default percentage is 15%

  • Automatic increase required, must be equal to or greater than 3% (year one), 4% (year two), 5% (year three) and 6% (year four and after)

  • Required employer contributions (match or non-elective)

  • Employer contributions fully vested after 2 years of service

  • May exclude certain employees from the employer contributions (under age 21 and/or never worked 1000 hours, Long-Term Part-Time Employees and Highly Compensated Employees)

  • Notice requirement – may combine the safe harbor notice with the ACA and QDIA notice
    
    Note that plans that include a QACA and are not exempt (not grandfathered) from the mandatory automatic enrollment (MAE) requirements must satisfy the requirements under the MAE requirements (detailed below).

• Eligible Automatic Contribution Arrangement (EACA): EACAs are another more exotic flavor of automatic enrollment that include some additional benefits, including the 90-day permissible withdrawal option for employees that experience buyer’s remorse after being enrolled, an extended deadline of six (6) months for completing the annual Average Deferral Percentage Test and the Average Contribution Percentage Test (ADP/ACP), and tax credits for start-up costs for small employers. However, plan sponsors should be aware that the ADP/ACP extended six-month deadline only applies if the EACA satisfies the uniformity requirement (in addition to the notice requirement). The uniformity provisions require the EACA to apply to all covered employees, not just some, and the EACA provisions must be in effect for the entire plan year.
  
  The uniformity requirement is where things start tasting like a little Chunky Monkey. For example, the plan will not qualify for the extended deadline for correcting a failed ADP/ACP Test if its provisions limit which employees are covered by the EACA. The default deferral percentage election must apply to all employees (unless the employee opts out) and may include the annual automatic increase. In addition, all covered employees must receive the annual EACA notice. In summary:

  • EACA provisions must apply to everyone covered by the plan to enjoy the extended 6-month testing window

  • EACA must be in effect for the full plan year, cannot be added mid-year

  • No required minimum or maximum deferral percentage (may set at 1%)*

  • Automatic increase is permitted but not required (may set at static 3%)*

  • Modifications to the EACA mid-year may affect the ability to use the 6-month extended testing window (e.g., changing the default deferral percentage mid-year or limiting to whom the EACA applies)

  • 90-day permissible withdrawals for employees who are automatically enrolled but change their mind. If an employee is not covered by the EACA, the 90-day withdrawal option is not available to that employee.

  • Plan must include a QDIA

  • Notice requirement – may combine EACA notice with the safe harbor notice (if applicable) and QDIA notice
    
    *Only if the plan is NOT subject to the mandatory automatic enrollment requirements under SECURE 2.0.
    
    Note: If the extended ADP/ACP Testing deadline is not a concern for the plan sponsor, the plan may exclude certain groups of employees from the EACA, including the notice requirement. If not all employees are covered by the EACA, the plan would be subject to the regular 2.5 month deadline for correcting a failed ADP/ACP Test.

Mandatory Automatic Enrollment (MAE) Rules

Lastly, the rocky road flavor applies for plans that are not exempt from the mandatory automatic enrollment provisions. To reiterate, if the plan is exempt (grandfathered), the plan sponsor may adopt an ACA, QACA or EACA at any time and not be subject to the following requirements. Non-exempt plans, even if they already included one of those types or arrangements, must conform to the following mandatory requirements effective for plan years beginning in 2025:

• Initial default deferral percentage must be at least 3% (maximum is 10%)

• Auto-escalation of the deferral percentage at 1% each plan year

• Maximum deferral percentage must be at least 10% (maximum is 15%)

• Default deferrals rules must apply to all covered employees

• Participants may still “opt out” at any time

• The defaults apply to all employees (even those that had previously elected not to defer or elected less than 3%)

• Must include the 90-day permissible withdrawal option

• Must include QDIA

In practical terms, this means that any plan that is subject to the mandatory automatic enrollment provisions must comply with the above rules. For employers who do not want to include automatic escalation of deferral percentages, the only option is to have the initial default percentage equal to 10%. The plan must also comply with limits on deferrals so that individuals do not exceed the annual §402(g) limit for the tax year (For 2025 the limits are $23,500 for those under age 50, $31,000 for those over 50 and $34,750 for plans that include the super catch-up for ages 60-63).

Consult with the plan’s service providers to assist in determining whether the plan is subject to the mandatory automatic enrollment provisions. The rules are complicated, and it is very important to ensure that the company’s retirement plan is operating according to the rules that apply to it.

Coordination Between Payroll and Recordkeeper

Automatic contributions arrangements of any flavor require significant oversight behind the scenes to run smoothly. The not so “automatic” part of automatic enrollment is the operational and administrative processes necessary to properly implement the plan terms, including timely enrolling employees, applying the correct default elections, deducting the correct deferrals and submitting the deferrals to the plan.

Many payroll service providers and recordkeepers now offer payroll integration, where elections are fed back to the payroll system, but that form of automation still hinges on the employer correctly identifying the employees that should be automatically enrolled. Larger plan sponsors typically have some integration built into the payroll system and the recordkeeper, but smaller employers may have more manual involvement in the process. Either way, the key is to have written policies and procedures in place to make sure that the automatic enrollment in your plan operates in accordance with the terms of the plan document.

The cherry on top for plans that contain automatic enrollment is that any missed deferral opportunities may be corrected under the new self-correction rules pursuant to Internal Revenue Service (IRS) Notice 2024-2. The new rules make it much easier to fix mistakes that occur with automatic enrollment, including an extended deadline to correct without penalty as long as the employer timely notifies the affected employee of the error. For details about correcting missed deferral opportunities (failure to properly implement automatic enrollment for an employee subject to the ACA), refer to 401(k)ology – Missed Deferral Opportunity Corrections – New Rules.

Conclusion

Whether you prefer vanilla (ACA), chocolate vanilla swirl (QACA), Chunky Monkey (EACA) or rocky road (MAE) – automatic enrollment in salary deferral plans is here to stay. Newly established 401(k) plans will need to learn to love rocky road, as mandatory automatic enrollment is the only flavor available going forward. Years from now, automatic enrollment will be second nature, and there has been some chatter in the industry that Secure 2.0 is just another baby step toward more sweeping legislation that eventually will require all 401(k) plans to provide automatic enrollment. For those that can, enjoy that vanilla ice cream now! On the other hand, maybe now is a good time to consider other flavors given that the industry is pushing so strongly in that new direction.

Regardless of your plan’s current terms, the positive outcome here is that expanded automatic enrollment results in more Americans saving for retirement and saving earlier. With uncertainty around the future of Social Security benefits, automatic enrollment may be the path for healthier retirement savings, especially for the new generations entering the workforce.

Newfront Retirement Services’ team of advisors and dedicated service team are always available to help plan sponsors determine how automatic enrollment can work for them. Feel free to contact me or just connect to keep up to date on all things ERISA 401(k): Joni_LinkedIn and 401(k)ology

Helpful Links:

• IRS Notice 2024-2

• IR-2025-09 Proposed Regulations on Automatic Enrollment Requirements for 401(k) and 403(b) Plans

• Retirement topics – Automatic Enrollment

• 401(k)ology – Missed Deferral Opportunity Corrections – New Rules

• 401(k)ology – Safe Harbor 401(k) Plans

• 401(k)ology – Impact of a Failed ADP/ACP Test

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