(b)lines Ask the Experts – Mandatory Contributions vs. Automatic Enrollment

“If the participant fails to make the mandatory contribution at time of initial eligibility, he/she may never participate in the plan and receive the plan’s employer contribution. Isn’t this just another form of automatic enrollment?” 

Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:

Mandatory contributions, which have been in place for some 403(b) plans for many years, particularly in the higher education sector, require employees to contribute as either a) a condition of employment, or b) pursuant to a one-time irrevocable election as to whether to participate in the plan (the scenario you describe in your question). Automatic enrollment, on the other hand, is neither a condition of employment nor is a condition of plan participation. Though employees are automatically enrolled in the plan with a certain percentage of employee contribution, the employee may opt out of the arrangement, and this ability to opt out does not affect the employee’s ability to participate in the plan in the future. The employee can simply resume salary deferrals at a later date, with no impact on employer contributions (except of course, if there is a matching contribution, such contributions would only be made for the period that employee deferrals are made to the plan).

Another key difference between automatic enrollment and a mandatory contribution formula is the tax treatment of contributions that are made by the employee. Under a mandatory contribution formula, the employee contribution is NOT treated as an elective deferral that is subject to the 402(g) limit. Thus, if an employee is required to make a 5% employee contribution, such an employee may make the 5% mandatory contribution AND contribute up to the 402(g) limit ($17,500 in 2013, $23,000 if age 50 or older). The 5% contribution does not reduce the employee’s elective deferral limit in any way; it is a contribution that may be made in addition to the elective deferral limit. It should be noted, however, that although the contributions are not considered to be elective deferrals for 402(g) limit purposes, they remain subject to FICA withholding.

However, contributions under an automatic enrollment scenario, though required under the plan, do count toward the 402(g) elective deferral limit, so automatic enrollment does not provide the opportunity for employee contributions in excess of the 402(g) limit.

The Experts hope this response will provide clarification of the distinction between mandatory contributions and contributions under an automatic enrollment scenario. We thank you and all of our other readers for their continued thought-provoking questions!