Reminder Employers May Implement “Negative Elections” to Increase 401(k) Participation

An employer may not, generally, defer compensation for an employee under a 401(k) plan without some positive action by an employee authorizing the deferral. However, employers looking to increase participation in their plans are increasingly implementing “negative” or “automatic” elections (or enrollment). With a negative or automatic election, the employer unilaterally—and without an affirmative election by an employee—deducts a stipulated percentage of compensation from the employee’s paycheck, but gives the employee the opportunity to make an election to discontinue the deferral at any time. The employer may treat an employee’s failure to make the election not to participate in the plan and to discontinue deferrals as consent to the salary reduction.

Advantages of negative elections.
The potential advantage of negative enrollment for an employer is that it may increase participation in its 401(k) plan, especially among lower-paid rank and file employees. As a result, negative enrollment may help the plan satisfy the applicable nondiscrimination requirements, because the employer will no longer be required to treat employees who don’t make affirmative deferral elections as having a deferral percentage of zero.

IRS approves negative elections.
The IRS has approved a negative election scenario under which the compensation of newly hired employees, who do not affirmatively elect to receive cash or have a specified amount contributed to the employer’s 401(k) plan, is automatically reduced by three percent. That amount is contributed on a pre-tax basis to the plan.

Employees are provided with a notice, at the time of hire, explaining the automatic compensation reduction election and their right to elect at any time not to have compensation reduction contributions made to the plan or to contribute a percentage other than 3 percent. In addition, employees are notified annually of their compensation reduction percentages and told about their right to modify the percentage.

Employees must have an “effective opportunity” to elect cash.
The IRS emphasizes that a negative election may not be executed unless employees are allowed an “effective opportunity” to elect to receive in cash an amount that would otherwise be deferred. An employee has an effective opportunity to elect to receive an amount in cash if the employee receives notice of the availability of the election and is allowed a reasonable period to make the election before the date on which the cash is currently available.

Notification of employees.
Employers that implement negative enrollment must also be certain to clearly inform employees of the fact that the salary reduction is being made, identify the percentage of compensation that is being deferred, and indicate whether the contributions will be made pre-tax or on an after-tax basis. Most especially, employees should be informed of their right to elect to discontinue the deferrals and the procedures for executing the election, including the time period during which elections must be made.

Employers should seek determination letters from IRS regarding negative enrollment features.
Negative elections may prove to be very beneficial to an employer, as well as to employees who may be forced into saving for retirement. However, negative elections are relatively new and may be difficult to implement in practice. Accordingly, an employer would be well advised to seek a determination letter from the IRS for approval of negative enrollment features contained in its 401(k) plan.

Cite: Rev. Rul. 98-30, I.R.B. 1998-24, 6-22-98.

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