401(K) Escalator Features
As part of the “Savings Initiative” guidance (Rev Rul 2009-30), employers may modify their automatic 401(k) enrolment plans to include a default escalator feature that will automatically periodically increase an employee’s 401(k) contribution without the employee’s affirmative election. Default contributions are treated as elective contributions. The ruling clarifies that (1) an automatic increase in a default contribution percentage may be based in part on increases in an employee’s plan compensation, and (2) the default contribution percentage for all eligible employees may be increased on other than the first day of the plan year. These situations were illustrated as follows in the Revenue Ruling:
Plan A - Default first plan year contribution is 4%. (Note: The maximum default contribution can never exceed 11%). Each subsequent plan year the contribution is increased by the greater of:
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One percentage point, or
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A number of percentage points calculated as 30% of the percentage increase in the eligible employee's base pay for such first pay period over the eligible employee's base pay for the immediately preceding pay period (rounded to the nearest whole percentage).
Example – Base pay at start of period was $3,000 per month and the base pay for the period immediately preceding the adjustment is $3,300. The percentage increase is 10%. 30% of the increase is 3% (30% of 10%). Thus, the employee’s 401(k) contribution will automatically be increased by 3 percentage points, but not to exceed a contribution rate of 11%. Had this been the employee’s second year, the contribution percentage would have increased to 7% (4% plus 3%).
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Plan B - Default first year contribution is 3%. (Note: The maximum default contribution under this plan, for plan years beginning after Dec. 31, 2019, can never exceed 15% (limit before 2020 was 10%). (SECURE Act; Notice 2020-86) Each subsequent year the contribution is increased by 1 percentage point until the maximum of 11% is reached. The increase is effective the first pay period after April 1. This type of plan is permitted even though the default contribution percentage increases on a date other than the first day of the plan year.
Employee May Elect Out - Any eligible employee may elect at any time not to make elective contributions (including not to make default contributions) or to have the employer contribute a different percentage of plan compensation.