On June 22, 1998, the Internal Revenue Service ("IRS") issued Revenue Ruling 98-30 which describes the circumstances in which automatic contributions made on behalf of employees will be treated as "elective" deferrals under a section 401(k) plan.

Automatic enrollment (or so called "negative election") programs have been developed in an effort to increase employee participation in retirement savings plans. Under these programs, an employee is automatically enrolled in a plan and contributions (at a set percentage or amount) are automatically deducted from his or her pay, unless the employee specifically elects not to participate. The appeal of such a program lies in raising the participation level of those employees who otherwise may not consider making elective contributions, thereby providing the employees with additional retirement savings. It would, at the same time, have the added benefit of raising the average deferral percentage of the rank and file for nondiscrimination testing purposes. While employees have the opportunity to affirmatively opt out under such a program, it is thought that many will continue to participate when they see the results of growing savings (especially with employer matching contributions) and the net change in pay, which is often smaller than the employees imagined. However, until the recent IRS ruling, it was unclear whether these automatic contributions would be considered "elective deferrals" for purposes of the section 401(k) rules. Because of this uncertainty, many employers have held off from adopting negative election programs.

The IRS ruling gives a "green light" to employers who wish to establish automatic participation programs for 401(k) deferrals. In general, the ruling provides that pre-tax contributions made by an employer on an employee’s behalf will not fail to be considered "elective" merely because such contributions are made pursuant to an automatic enrollment arrangement so long as the employee has an "effective opportunity" to elect out of the arrangement and receive cash. Under the ruling, an employee will have an "effective opportunity" to do so if (1) the employee is notified of the right to make such an election, and (2) he or she has a reasonable opportunity beforehand to elect to receive cash.

Employers wishing to implement a negative election program should ensure that adequate notice is given to employees about the program. In general, an employer can be confident that it has done so where (as was being done by the employer described in Revenue Ruling 98-30) it notifies employees about the program (including the opportunity to elect out) when they first becomes eligible for the plan and at least annually thereafter.

In addition, there are other issues an employer should consider when adopting this type of program. While this program will likely increase participation and ease administrative paperwork, employers will need to decide (1) the percentage or amount to be automatically contributed on behalf of employees and (2) how contributions will be invested in the absence of specific investment elections by the employee. In this regard, it should be kept in mind that the Department of Labor takes the position that a participant will not be considered to have exercised control over the assets of his or her individual account under a negative election scheme. Accordingly, there will be no protection under ERISA section 404(c), which may otherwise shield the employer from liability for investments made at the direction of the participants, until the employee actually makes an investment election under the plan. Additionally, state laws regulating wage payment and collection issues (that are not otherwise preempted by ERISA) should be examined for any conflicting standards prior to implementing such a program.