Serendipity and the QACA

A Better 401k

Serendipity. It doesn’t happen everyday, but when it does, it’s as sweet as the frozen hot chocolate they serve at the iconic Upper East Side eatery. Recently a colleague approached me and asked if I had a creative solution for a plan with abysmal plan participation and a multitude of testing issues. As fortune would have it, I’d been working on another plan that had been designed as a Qualified Automatic Contribution Arrangement (QACA). And the lightbulb went on!

QACA plan design has been available since 2008. Essentially the QACA is a 401(k) that adds automatic enrollment with an automatic escalation feature, along with a modified safe harbor matching contribution. In return, the sponsor enjoys an automatic pass on ADP and ACP tests, exemption from top heavy status, and the ability to apply a vesting schedule to the safe harbor matching contribution. Quick highlights:

• Must adopt on the first day of a plan year
• Must do automatic enrollment; the initial rate must be at least 3% (can be as much as 10%)
• Must do automatic escalation; must increase at least 1% per year until a minimum deferral limit of 6% is reached
• Required match must be 100% of the first 1%, plus 50% on the next 5% deferred
• A 2 Year of Service requirement for vesting is permitted

In this case, the plan sponsor had plan participation of only 12%. The owners did not participate at all to avoid ADP/ACP failure and a required minimum contribution due to top heavy status. Adding the automatic enrollment with automatic escalation will solve their plan participation issues.

A Safe Harbor Plan

To solve the testing issues, safe harbor is the obvious favorite, but for many plan sponsors, the sticking point is the required matching contribution, particularly the potential cost of the contribution when a plan is automatically enrolled. Clearly a financial commitment from the plan sponsor is necessary, but with the QACA the key is the vesting schedule.

A standard safe harbor plan requires a plan sponsor to fully vest employer contributions immediately. A QACA gives a plan sponsor the ability to apply a 2 year of service requirement before full vesting. If an employee leaves before he has 2 years of service, his matching account is forfeited and used to offset the cost of future matching contributions. In this case, the vesting schedule makes the plan design much more attractive to the plan sponsor, and ultimately much more affordable.

As we come to the end of the 2015 testing season, now might be the perfect time to ask yourself if the QACA design is right for you.