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A recent call with a financial advisor in Virginia reflects a common question on Qualified Automatic Contribution Arrangements (QACAs).
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business.
“My client has sponsored a Savings Incentive Match Plan for Employees (SIMPLE) IRA plan with a matching contribution and will be transitioning to a 401(k) plan with a qualified automatic contribution arrangement (QACA) for next year. Is it possible for the 401(k) plan to provide a QACA match formula that is like the SIMPLE IRA match formula to which employees have become accustomed (i.e., 100% of the first 3% of compensation deferred)?”
While a SIMPLE IRA-style match limited to 3% of compensation would not, by itself, satisfy the QACA matching requirement, a QACA 401(k) plan may generally use an alternative “enhanced” QACA matching formula if it meets certain requirements.
The basic 401(k) QACA safe harbor matching formula is a 100% match on elective deferrals up to 1% of compensation, plus a 50% match on deferrals exceeding 1% but not exceeding 6% of compensation (for a maximum aggregate match of 3.5% of compensation).
As with traditional safe harbor matching contributions, a plan may generally use an alternative “enhanced” QACA matching formula if the following requirements are met:
At any given rate of elective deferrals, the aggregate match under the alternative formula is equal to or greater than the aggregate amount of matching contributions that would be made under the basic matching formula;
The rate of matching contributions does not increase as the rate of elective deferrals increases; and
The rate of matching contributions that would apply to any eligible highly compensated employee (HCE) is not greater than the rate of matching contributions that would apply to any eligible nonHCE who has the same rate of elective deferrals.
(See Treas. Reg. § 1.401(k)-3(c)(3), (4) and (k)(2)).
It is important to note that the first requirement does not mandate that the rate of matching contributions be equal to or greater than the rate under the basic formula at each rate of deferral. Rather, it requires that the aggregate amount of matching contributions be equal to or greater than the aggregate match at each deferral rate under the basic formula.
Therefore, a plan sponsor may “front-load” an enhanced QACA formula by providing a greater rate of match at lower rates of deferral and a reduced rate of match at higher deferral rates. For instance, a plan could provide an enhanced QACA match of 100% of the first 3% of compensation deferred, plus 25% of the next 2% of compensation deferred. This formula satisfies the QACA requirements because it provides at least the basic QACA matching contribution at every deferral rate.
Example: Assume an employee earns $100,000 and defers 5% of compensation. Under this enhanced QACA formula, the employee would receive a $3,500 employer match ($3,000 plus $500), compared with $3,000 under the basic QACA formula. At a 6% deferral rate, both formulas would provide a $3,500 match.
A QACA 401(k) plan cannot simply duplicate the SIMPLE IRA's 100% match on the first 3% of compensation deferred because it would not satisfy the QACA safe harbor matching requirements. However, an enhanced QACA formula of 100% of the first 3% deferred, plus 25% of the next 2% deferred, would satisfy these requirements. This approach preserves the familiar SIMPLE IRA match on the first 3% of compensation while allowing employees to receive a maximum employer match of 3.5% when they defer at least 5% of compensation.