IRS fine-tunes auto-enrollment exemption, explains new correction

IRS’s grab bag of guidance on the SECURE 2.0 Act of 2022 (Div. T of Pub. L. No. 117-328) provides reassurance for 401(k) and 403(b) plan sponsors exempt from the law’s automatic enrollment mandate for new plans. Notice 2024-2 explains how the exemption for existing plans applies after plan mergers and spinoffs, including those involving multiple-employer plans (MEPs) and pooled employer plans (PEPs). The notice also provides clarity on the act’s new self-correction for auto-enrollment errors. However, sponsors of plans subject to the auto-enrollment mandate still need guidance on other implementation issues before the mandate takes effect with the 2025 plan year.

Auto-enrollment mandate

Starting with 2025 plan years, 401(k) and 403(b) plans established on or after Dec. 29, 2022 — SECURE 2.0’s enactment date — must begin automatically enrolling employees into an eligible automatic contribution arrangement (EACA) that has certain features, including the following:

• Plans must automatically enroll employees at an initial rate between 3% and 10% of compensation, but employees must be able to elect a different contribution rate or opt out altogether.
• Employees can withdraw their automatic contributions during the 90-day period after the initial contribution.
• The automatic contribution rate must increase by 1% after each completed year of participation until the rate reaches at least 10% (but not more than 15%) of compensation, unless a participant elects a different contribution rate or opts out.

This article uses the term “nonexempt” to describe plans that are subject to the auto-enrollment mandate. For a detailed discussion of the auto-enrollment mandate and EACA requirements, as well as other exemptions not addressed by the notice, see Road-testing SECURE 2.0’s auto-enrollment mandate for new DC plans (Feb. 14, 2023).

Pre-enactment plans get a pass

A broad exception from the auto-enrollment mandate applies to 401(k) and 403(b) plans “established” before Dec. 29, 2022. The notice refers to these as “pre-enactment” plans. A 401(k) plan falls into this category if the plan’s terms regarding elective deferrals were initially adopted before Dec. 29, 2022 — even if those terms took effect on a later date. For 403(b) plans, the exemption applies if the plan was established before Dec. 29, 2022, without regard to the adoption date of plan terms providing for salary reduction agreements.

Single-employer plan mergers and spin-offs

The notice confirms that single-employer plans will retain their exempt status in certain circumstances. When two pre-enactment plans merge, the surviving plan retains pre-enactment status. A plan spun off from a pre-enactment plan is also treated like a pre-enactment plan.

If a nonexempt plan merges with a pre-enactment plan, the ongoing plan generally won’t be exempt. However, the pre-enactment exemption continues to apply if the merger occurs in connection with a corporate transaction that is eligible for relief from minimum coverage testing and meets the following conditions:

• The plan merger is completed during the minimum coverage testing relief period (i.e., generally the end of the plan year after the year of the corporate transaction).
• The pre-enactment plan is designated as the surviving plan.

The notice doesn’t explain how the ongoing plan should treat premerger contribution elections — including default elections — for employees of the formerly nonexempt plan. For mergers that don’t meet these conditions, the notice doesn’t address how to apply the auto-enrollment requirements to employees of the formerly exempt plan (e.g., whether employees without premerger contribution elections must be auto-enrolled in the ongoing plan). In the absence of additional clarification from IRS, employers merging nonexempt and pre-enactment plans may want to speak to legal counsel.

Guidance for pre-enactment MEPs

SECURE 2.0 says the auto-enrollment mandate applies to employers that newly adopt a MEP — including a PEP — on or after Dec. 29, 2022, even if the MEP was already established. This prevents an employer that doesn’t sponsor a pre-enactment plan from evading the auto-enrollment mandate by adopting a pre-enactment MEP. However, the act doesn’t specify whether pre-enactment plan sponsors lose the exemption when merging a plan into a MEP — or transitioning from one MEP to another or to an individually designed plan.

The notice clarifies that the exemption continues to apply to MEP participants in certain situations:

• When a pre-enactment single-employer plan merges into a pre-enactment MEP, the exemption would continue to apply to that participating employer. However, the notice is silent on whether the outcome would differ for a merger into a post-enactment MEP. This may be particularly relevant for pre-enactment 403(b) plan sponsors since 403(b) MEPs weren’t available before SECURE 2.0. Clarification is needed.
• Participating employers in a pre-enactment MEP won’t lose the exemption when a nonexempt plan merges into the MEP. In that situation, only the sponsor of the nonexempt plan must comply with the auto-enrollment mandate as if it was a separate plan.
• A plan spun off from a pre-enactment MEP will be exempt if the employer was treated as sponsoring a pre-enactment plan while participating in the MEP.

New deferral-only arrangements generally aren’t exempt

SECURE 2.0 allows employers that don’t sponsor a retirement plan to offer a deferral-only 401(k) or 403(b) plan, which is a safe harbor plan and treated as not top-heavy. The notice confirms that these plans must comply with the auto-enrollment mandate unless another exemption applies (e.g., the exemption for new or small employers).

Safe-harbor corrections for elective deferral failures

SECURE 2.0 added to the Internal Revenue Code a statutory self-correction safe harbor for automatic enrollment and escalation errors. Sponsors of 401(k), 403(b) and governmental 457(b) plans and IRAs generally can self-correct reasonable errors in administering auto-enrollment and auto-escalation up to 9-1/2 months after the end of the plan year in which the error first occurred. (A shorter correction window applies if an employee notifies the sponsor about the error). Affected individuals must receive a notice of the correction within 45 days after correct deferrals begin. This provision makes permanent the temporary safe harbor under IRS’s Employee Plans Compliance Resolution System (EPCRS), which had been available to 401(k) and 403(b) plans but expired for failures beginning after Dec. 31, 2023.

Notice 2024-2 provides the following guidance on the new safe harbor:

• Effective date. The permanent safe harbor is available for errors with a statutory correction deadline after Dec. 31, 2023. This means calendar-year plans can generally use the safe harbor for errors that arose in 2023 (i.e., the statutory deadline for correcting these errors is Oct. 15, 2024).
• Deadline for missed matching contributions. Employers that timely self-correct won’t have to make a qualified nonelective contribution (QNEC) for the lost deferral opportunity but must pay any matching contributions that participants would have received had the error not occurred (adjusted for earnings). For errors occurring after Dec. 31, 2023, the allocation of missed matching contributions must be made within a reasonable period after correct deferrals begin. While reasonableness depends on the facts and circumstances, the notice deems as reasonable a corrective allocation made by the last day of the sixth month starting after correct deferrals begin (or would have begun for former employees) — a shorter time frame than under the EPCRS safe harbor. For errors that began before Jan. 1, 2024, the notice confirms that sponsors of 401(k) and 403(b) plans can still follow the EPCRS safe harbor, which allows corrective allocations of matching contributions up to the end of the third plan year after the year the error occurred.
• Applies to former employees. While EPCRS is silent on the temporary safe harbor’s application to former employees, the act’s permanent safe harbor is available for both current and former employees. Former employees must still receive corrective allocations relating to missed matching contributions. However, IRS explains that the required correction notice provided to former employees won’t have to include a statement that correct deductions have begun or an explanation about increasing elections to make up for missed deferrals. That information would be irrelevant to terminated employees since they wouldn’t be eligible to contribute.