The SECURE Act 2.0 Auto-Enrollment Mandate is Now Live: IRS Offers Key Guidance

by Prof. Robert Bloink and Prof. William H. Byrnes

The SECURE Act 2.0 contained an automatic enrollment mandate that will impact nearly every new small business retirement plan going forward. Auto-enrollment features have gained significant traction in recent years. Many find that auto-enrollment is highly beneficial when it comes to encouraging all American workers to save for retirement. In fact, some studies show that more than half of all American workers who believed they were contributing to employer-sponsored plans were not contributing at all. Many of those workers thought they had been automatically enrolled. Starting this year, the sweeping federal auto-enrollment provision is effective. The IRS has now proposed regulations that small business owners can use as key guidance in implementing their auto-enrollment features.

SECURE Act 2.0 Auto-Enrollment: Background

Starting with the 2025 tax year, the SECURE Act 2.0 will require employers that establish new 401(k) or 403(b) plans to auto-enroll employees in the savings plans. The minimum auto-enrollment contribution rate will range from 3% to 10% during an “initial period” that ends on the last day of the following plan year. Each subsequent year, the minimum contribution rate will then increase by 1% until the rate reaches at least 10% (not to exceed 15%).

Under the law, small business employers with 10 or fewer employees and new businesses will be exempt from the auto-enrollment requirement. Plans established before December 29, 2022 are considered to be “grandfathered” and are not subject to the auto-enrollment mandate (the plan is grandfathered if it was adopted before this date, even if the plan’s terms for providing elective deferrals are effective later).

Proposed Regulations: The Basics

Whether an eligible automatic contribution arrangement (EACA) satisfies the mandate is determined on a plan year basis. The IRS proposed regulations clarify that an EACA satisfies the auto-enrollment rule only if the EACA covers all employees in the plan who are eligible to have contributions made on their behalf (including eligible long-term part-time employees).

Employees are permitted to opt-out or choose a contribution rate that differs from the automatic schedule. The EACA won’t be disqualified because it does not cover employees with affirmative elections in place on the date the plan was required to satisfy the auto-enrollment mandate. The default election under the EACA must provide that a uniform percentage of each employee’s compensation will be deferred into the plan (again, employees are permitted to opt out or change their contribution rates).

Plans can be designed to redetermine the employee’s “initial period” if the employee does not make a default elective deferral for an entire plan year after the employee’s initial period began. For example, this could happen if an employee became ineligible to contribute or if the employee chose a contribution rate below the default rate.

Exceptions to the Auto-Enrollment Mandate

The proposed regulations clarify that exceptions to the mandate do exist. New businesses that have been in existence for less than three years are not subject to the auto-enrollment mandate if they elect to sponsor a 401(k) or 403(b) plan. For purposes of the three-year limit, the time the business has existed is aggregated with any predecessor employers.

With respect to the small business exemption, the auto-enrollment mandate does not apply until the first plan year that begins 12 months after the close of the first tax year during which the employer is considered to normally employ more than 10 employees. For this purpose, the regulations clarify that an employer "normally employs" less than 11 employees during a calendar year if it had fewer than 11 employees on at least 50 percent of its typical business days that year.

Both full-time and part-time employees are counted, but self-employed individuals and directors are not counted. Each part-time employee is counted as a fraction of an employee.

For employers that participate in a MEP or PEP, small-employer status is determined on an employer-by-employer basis (so that all participants in the MEP are not aggregated in determining the number of employees the employer normally employs).

SIMPLE 401(k) plans and governmental plans are also exempt from the mandate.

With respect to grandfathered plans (“pre-enactment plans”), amendments will not impact the plan’s grandfathered status (so long as the amendment does not involve adopting a MEP or a plan merger). When a pre-enactment plan merges with a post-enactment plan, the surviving plan is treated as a post-enactment plan subject to the auto-enrollment mandate. When two pre-enactment plans merge, the surviving plan continues to be treated as a pre-enactment plan.

Pre-enactment plans can merge into MEPs after December 29, 2022 without risking their grandfathered status regardless of when the MEP was established (the post-merger MEP is treated as a pre-enactment plan with respect to the merging employer).

Conclusion

The IRS proposed regulations are effective for plan years that begin more than six months after final regulations are published. Until then, plans can use a reasonable, good faith interpretation of the proposed regulations when implementing the auto-enrollment mandate for 2025 and beyond.