In Revenue Ruling 2000-8, the IRS recently issued guidance on "negative" 401(k) plan elections. In the ruling, the IRS reiterated its earlier position set forth in Revenue Ruling 98-30 that where a profit sharing/401(k) plan provides that a fixed percentage of an employee's compensation will be contributed to the plan unless the employee affirmatively elects to receive the amount in cash, such deferrals will qualify as elective contributions under a cash or deferred arrangement. This fixed deferral percentage is the "default" provision under the plan. The IRS made clear that the employee must be given adequate notice and a reasonable time to make a different election, e.g., no deferral or a different amount of deferral, prior to the commencement of the deferrals, and that the employee must be allowed to revoke the default election at any time. The IRS also explained that the same rule would apply where the plan requires a period of service before an employee becomes eligible to have the employer make elective contributions to the plan on his or her behalf.
Employers may have a strong interest in implementing a "negative" election procedure for at least two reasons. First, the "negative" election would likely increase the number of employees participating in the plan, thus fostering the objective of the Department of Labor ("DOL") (and presumably, the employer) of increasing the number of employees actively saving for retirement. In fact, the proliferation of the negative election process has had a noticeable impact on employee participation rates. Available information suggests that conversion to a negative election may result in as much as a 20% increase in participation rate over pre-negative election enrollment.1 Second, for plans which have experienced discrimination testing problems, the use of the "negative" election should improve the chances that the plan will satisfy such testing, thus avoiding the timely process of returning contributions to highly compensated employees or the costly remedy of making additional contributions (QNECS) to the plan on behalf of non-highly compensated employees. In addition, decreasing the chance that a plan would fail the discrimination testing necessarily minimizes the chance that a plan sponsor would fail to take no corrective action and jeopardize the plan's qualification.
Department of Labor Position. Importantly, however, the DOL has yet to respond to an advisory opinion request seeking a ruling that the "negative" election procedure would not be subject to certain State labor laws.2 Specifically, the advisory opinion request seeks clarification that Section 514(a) of ERISA preempts certain state withholding laws which would otherwise preclude operation of the negative election. Neither revenue ruling addresses this issue. In question are certain state labor laws requiring a signed written consent from the employee (and, in some cases, the spouse) prior to any non-statutory withholding (e.g., mandatory or elective deferrals). For example, New York Labor Law section 193 provides, in pertinent part, as follows:
1. No employer shall make any deduction from the wages of an employee, except deductions which:
a. Are made in accordance with the provisions of any law or any rule or regulation issued by any governmental agency; or
b. Are expressly authorized in writing by the employee and are for the benefit of the employee.
Prior DOL positions suggest that the DOL will find that ERISA preemption applies. For example, in Advisory Opinion 94-27A,3 the DOL held that NY Labor Law section 193 was preempted in the context of a salary reduction arrangement for contributions made through a telephonic or interactive voice response system. The factual similarities should provide the DOL with ample justification to extend ERISA preemption to the "negative" election.
In summary, while IRS Revenue Ruling 2000-8 permits a fixed percentage of an employee's compensation to be contributed to the plan as the default deferral percentage unless the employee affirmatively elects to receive the amount in cash, until the DOL blesses the "negative" election process, employers should review applicable state laws or, as the case may be, consider delaying any immediate conversion to such method.
1. ERISA Report for Plan Sponsors, Reish & Luftman (October 1998).
2. Application for DOL Opinion, Reish & Luftman (March 15, 1999).
3. DOL Advisory Opinion 94-27A (July 14, 1994); see also DOL Advisory Opinion 96-01A (February 8, 1996) (finding that Puerto Rico law preempted by ERISA to the extent it prohibited repayment of loans through payroll deductions to employee benefit plans).
Employers may have a strong interest in implementing a "negative" election procedure for at least two reasons. First, the "negative" election would likely increase the number of employees participating in the plan, thus fostering the objective of the Department of Labor ("DOL") (and presumably, the employer) of increasing the number of employees actively saving for retirement. In fact, the proliferation of the negative election process has had a noticeable impact on employee participation rates. Available information suggests that conversion to a negative election may result in as much as a 20% increase in participation rate over pre-negative election enrollment.1 Second, for plans which have experienced discrimination testing problems, the use of the "negative" election should improve the chances that the plan will satisfy such testing, thus avoiding the timely process of returning contributions to highly compensated employees or the costly remedy of making additional contributions (QNECS) to the plan on behalf of non-highly compensated employees. In addition, decreasing the chance that a plan would fail the discrimination testing necessarily minimizes the chance that a plan sponsor would fail to take no corrective action and jeopardize the plan's qualification.
Department of Labor Position. Importantly, however, the DOL has yet to respond to an advisory opinion request seeking a ruling that the "negative" election procedure would not be subject to certain State labor laws.2 Specifically, the advisory opinion request seeks clarification that Section 514(a) of ERISA preempts certain state withholding laws which would otherwise preclude operation of the negative election. Neither revenue ruling addresses this issue. In question are certain state labor laws requiring a signed written consent from the employee (and, in some cases, the spouse) prior to any non-statutory withholding (e.g., mandatory or elective deferrals). For example, New York Labor Law section 193 provides, in pertinent part, as follows:
1. No employer shall make any deduction from the wages of an employee, except deductions which:
a. Are made in accordance with the provisions of any law or any rule or regulation issued by any governmental agency; or
b. Are expressly authorized in writing by the employee and are for the benefit of the employee.
Prior DOL positions suggest that the DOL will find that ERISA preemption applies. For example, in Advisory Opinion 94-27A,3 the DOL held that NY Labor Law section 193 was preempted in the context of a salary reduction arrangement for contributions made through a telephonic or interactive voice response system. The factual similarities should provide the DOL with ample justification to extend ERISA preemption to the "negative" election.
In summary, while IRS Revenue Ruling 2000-8 permits a fixed percentage of an employee's compensation to be contributed to the plan as the default deferral percentage unless the employee affirmatively elects to receive the amount in cash, until the DOL blesses the "negative" election process, employers should review applicable state laws or, as the case may be, consider delaying any immediate conversion to such method.
1. ERISA Report for Plan Sponsors, Reish & Luftman (October 1998).
2. Application for DOL Opinion, Reish & Luftman (March 15, 1999).
3. DOL Advisory Opinion 94-27A (July 14, 1994); see also DOL Advisory Opinion 96-01A (February 8, 1996) (finding that Puerto Rico law preempted by ERISA to the extent it prohibited repayment of loans through payroll deductions to employee benefit plans).