To amend the Internal Revenue Code of 1986 to increase participation and savings in cash or deferred plans through automatic contribution and default investment arrangements, and for other purposes.

October 4, 2005

Mr. SANTORUM (for himself and Mr. BENNETT) introduced the following bill; which was read twice and referred to the Committee on Finance

To amend the Internal Revenue Code of 1986 to increase participation and savings in cash or deferred plans through automatic contribution and default investment arrangements, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the `401(k) Enhancement Act: Encouraging Retirement Savings'.

SEC. 2. INCREASING PARTICIPATION AND SAVINGS IN CASH OR DEFERRED PLANS THROUGH AUTOMATIC CONTRIBUTION ARRANGEMENTS.

(a) In General- Section 401(k) of the Internal Revenue Code of 1986 (relating to cash or deferred arrangement) is amended by adding at the end the following new paragraph:

`(13) NONDISCRIMINATION REQUIREMENTS FOR AUTOMATIC CONTRIBUTION TRUSTS-

`(A) IN GENERAL- A cash or deferred arrangement shall be treated as meeting the requirements of paragraph (3)(A)(ii) if such arrangement constitutes an automatic contribution trust.

`(B) AUTOMATIC CONTRIBUTION TRUST-

`(i) IN GENERAL- For purposes of this paragraph, the term `automatic contribution trust' means an arrangement--

`(I) except as provided in clause (ii), under which each employee eligible to participate in the arrangement is treated as having elected to have the employer make elective contributions in an amount equal to the applicable percentage of the employee's compensation, and

`(II) which meets the requirements of subparagraphs (C) and (D).

`(ii) EXCEPTIONS-

`(I) EMPLOYER ELECTION WITH RESPECT TO EXISTING EMPLOYEES- An employer may elect not to have clause (i)(I) apply to all employees who were eligible to participate in the arrangement (or a predecessor arrangement) immediately before the first date on which the arrangement is an automatic contribution trust. The employer shall make the election under this subclause before such first date.

`(II) ELECTION OUT- Each employee eligible to participate in the arrangement may specifically elect not to have contributions made under clause (i), and such clause shall cease to apply to compensation paid on or after the effective date of the election.

`(iii) APPLICABLE PERCENTAGE- For purposes of this subparagraph--

`(I) IN GENERAL- The term `applicable percentage' means, with respect to any employee, the percentage (not less than 3 percent) determined under the arrangement.

`(II) INCREASE IN PERCENTAGE- In the case of the second plan year beginning after the first date on which the election under clause (i)(I) is in effect with respect to the employee and any succeeding plan year, the applicable percentage shall be a percentage equal to the sum of the applicable percentage for the employee as of the close of the preceding plan year plus the number of percentage points (not less than 1 percentage point) specified by the plan. Such increase shall continue until the applicable percentage is at least 10 percent or such higher percentage specified by the plan.

`(C) MATCHING OR NONELECTIVE CONTRIBUTIONS-

`(i) IN GENERAL- The requirements of this subparagraph are met if, under the arrangement, the employer--

`(I) makes matching contributions on behalf of each employee who is not a highly compensated employee in an amount equal to 50 percent of the elective contributions of the employee to the extent such elective contributions do not exceed 6 percent of compensation; or

`(II) is required, without regard to whether the employee makes an elective contribution or employee contribution, to make a contribution to a defined contribution plan on behalf of each employee who is not a highly compensated employee and who is eligible to participate in the arrangement in an amount equal to at least 3 percent of the employee's compensation,

The rules of clauses (ii) and (iii) of paragraph (12)(B) shall apply for purposes of subclause (I). The rules of paragraph (12)(E)(ii) shall apply for purposes of subclauses (I) and (II).

`(ii) OTHER PLANS- An arrangement shall be treated as meeting the requirements under clause (i) if any other plan maintained by the employer meets such requirements with respect to employees eligible under the arrangement.

`(D) NOTICE REQUIREMENTS-

`(i) IN GENERAL- The requirements of this subparagraph are met if the requirements of clauses (ii) and (iii) are met.

`(ii) REASONABLE PERIOD TO MAKE ELECTION- The requirements of this clause are met if each employee to whom subparagraph (B)(i) applies--

`(I) receives a notice explaining the employee's right under the arrangement to elect not to have elective contributions made on the employee's behalf, and how contributions made under the arrangement will be invested in the absence of any investment election by the employee, and

`(II) has a reasonable period of time after receipt of such notice and before the first elective contribution is made to make such election.

`(iii) ANNUAL NOTICE OF RIGHTS AND OBLIGATIONS- The requirements of this clause are met if each employee eligible to participate in the arrangement is, within a reasonable period before any year, given notice of the employee's rights and obligations under the arrangement.

The requirements of clauses (i) and (ii) of paragraph (12)(D) shall be met with respect to the notices described in clauses (ii) and (iii) of this subparagraph.'

(b) Matching Contributions- Section 401(m) of the Internal Revenue Code of 1986 (relating to nondiscrimination test for matching contributions and employee contributions) is amended by redesignating paragraph (12) as paragraph (13) and by inserting after paragraph (11) the following new paragraph:

`(12) ALTERNATE METHOD FOR AUTOMATIC CONTRIBUTION TRUSTS- A defined contribution plan shall be treated as meeting the requirements of paragraph (2) with respect to matching contributions if the plan--

`(A) meets the contribution requirements of subparagraphs (B)(i) and (C) of subsection (k)(13);

`(B) meets the notice requirements of subparagraph (D) of subsection (k)(13); and

`(C) meets the requirements of paragraph (11)(B) (ii) and (iii).'.

(c) Exclusion From Definition of Top-Heavy Plans-

(1) ELECTIVE CONTRIBUTION RULE- Clause (i) of section 416(g)(4)(H) of the Internal Revenue Code of 1986 is amended by inserting `or 401(k)(13)' after `section 401(k)(12)'.

(2) MATCHING CONTRIBUTION RULE- Clause (ii) of section 416(g)(4)(H) of such Code is amended by inserting `or 401(m)(12)' after `section 401(m)(11)'.

(d) Definition of Compensation-

(1) BASE PAY OR RATE OF PAY- The Secretary of the Treasury shall, not later than December 31, 2006, modify Treasury Regulation section 1.414(s)-1(d)(3) to facilitate the use of the safe harbors in sections 401(k)(12), 401(k)(13), 401(m)(11), and 401(m)(12) of the Internal Revenue Code of 1986, and in Treasury Regulation section 1.401(a)(4)-3(b), by plans that use base pay or rate of pay in determining contributions or benefits. Such modifications shall include increased flexibility in satisfying section 414(s) of such Code in any case where the amount of overtime compensation payable in a year can vary significantly.

(2) APPLICATION OF REQUIREMENTS TO SEPARATE PAYROLL PERIODS- Not later than December 31, 2005, the Secretary of the Treasury shall issue rules under subparagraphs (B)(i) and (C)(i) of section 401(k)(13) of such Code and under clause (i) of section 401(m)(12)(A) of such Code that, effective for plan years beginning after December 31, 2005, permit such requirements to be applied separately to separate payroll periods based on rules similar to the rules described in Treasury Regulation sections 1.401(k)-3(c)(5)(ii) and 1.401(m)-3(d)(4).

(e) Section 403(b) CONTRACTS- Paragraph (11) of section 401(m) of the Internal Revenue Code of 1986 is amended by adding at the end the following:

`(C) SECTION 403(b) CONTRACTS- An annuity contract under section 403(b) shall be treated as meeting the requirements of paragraph (2) with respect to matching contributions if such contract meets requirements similar to the requirements under subparagraph (A).'.

(f) Investments and Preemption-

(1) CONTROL DEEMED TO HAVE BEEN EXERCISED WITH RESPECT TO DEFAULT INVESTMENT ARRANGEMENTS- Section 404(c) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1104(c)) is amended by adding at the end the following new paragraph:

`(4) TREATMENT OF DEFAULT INVESTMENT ARRANGEMENT-

`(A) IN GENERAL- A participant in an individual account plan shall, for purposes of paragraph (1), be treated as exercising control over the assets in the account with respect to the amount of contributions made under a default investment arrangement.

`(B) DEFAULT INVESTMENT ARRANGEMENT DEFINED- For purposes of this paragraph, the term `default investment arrangement' means an arrangement--

`(i) which meets the requirements of subparagraph (C),

`(ii) under which the participant is treated as having elected to have the employer exercise control over the assets in his account until the participant specifically elects to exercise such control, and

`(iii) under which assets described in clause (ii) are invested in accordance with regulations prescribed by the Secretary.

Such regulations shall provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with long-term capital appreciation. The regulations shall also provide guidance on the designation of default investments in individual account plans that are not designed to meet the requirements of this section.

`(C) NOTICE REQUIREMENTS-

`(i) TIME FOR NOTICE- The administrator of a default investment arrangement shall, within a reasonable period before each plan year, give to each employee to whom a default investment arrangement applies for such plan year notice of the employee's rights and obligations under the arrangement which--

`(I) is sufficiently accurate and comprehensive to apprise the employee of such rights and obligations, and

`(II) is written in a manner calculated to be understood by the average employee to whom the arrangement applies.

`(ii) FORM OF NOTICE; RESPONSE- A notice shall not be treated as meeting the requirements of clause (i) with respect to an employee unless--

`(I) the notice includes a notice explaining the employee's right under the arrangement to elect to exercise control over the assets in his account,

`(II) the employee has a reasonable period of time after receipt of the notice described in subclause (I) and before the assets are first invested to make such election, and

`(III) the notice explains how contributions made under the arrangement will be invested in the absence of any investment election by the employee.'.

(2) PREEMPTION OF CONFLICTING STATE REGULATION- Section 514 of such Act (29 U.S.C. 1144) is amended by adding at the end the following new subsection:

`(e) Automatic Contribution Arrangements-

`(1) IN GENERAL- Notwithstanding any other provision of this section, any law of a State which would directly or indirectly prohibit or restrict the inclusion in any plan of an automatic contribution arrangement shall be superseded. The Secretary may prescribe regulations which would establish minimum standards that such arrangements would be required to satisfy in order for this subsection to apply.

`(2) AUTOMATIC CONTRIBUTION ARRANGEMENT DEFINED- For purposes of this subsection, the term `automatic contribution arrangement' means an arrangement--

`(A) which meets the requirements of paragraph (3),

`(B) under which a participant may elect to have the employer make payments as contributions under the plan on behalf of the participant, or to the participant directly in cash,

`(C) under which the participant is treated as having elected to have the employer make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or specifically elects to have such contributions made at a different percentage), and

`(D) under which contributions described in subparagraph (C) are invested in accordance with regulations prescribed by the Secretary.

Such regulations shall provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with long-term capital appreciation.

`(3) NOTICE REQUIREMENT-

`(A) IN GENERAL- The administrator of an individual account plan shall, within a reasonable period before each plan year, give to each employee to whom an automatic contribution arrangement applies for such plan year notice of the employee's rights and obligations under the arrangement which--

`(i) is sufficiently accurate and comprehensive to apprise the employee of such rights and obligations, and

`(ii) is written in a manner calculated to be understood by the average employee to whom the arrangement applies.

`(B) OTHER REQUIREMENTS- A notice shall not be treated as meeting the requirements of subparagraph (A) with respect to an employee unless--

`(i) the notice includes a notice explaining the employee's right under the arrangement to elect not to have elective contributions made on the employee's behalf (or to elect to have such contributions made at a different percentage),

`(ii) the employee has a reasonable period of time after receipt of the notice described in clause (i) and before the first elective contribution is made to make such election, and

`(iii) the notice explains how contributions made under the arrangement will be invested in the absence of any investment election by the employee.'.

(g) Corrective Distributions-

(1) IN GENERAL- Section 414 of the Internal Revenue Code of 1986 (relating to definitions and special rules) is amended by adding at the end the following new subsection:

`(w) Automatic Contribution Arrangements-

`(1) IN GENERAL- For purposes of this title, the amount of any corrective distribution from a plan shall be treated as if such amount had never been held in such plan and shall be treated as a payment of compensation from the employer maintaining the plan to the employee receiving such distribution.

`(2) CORRECTIVE DISTRIBUTION- For purposes of this subsection, the term `corrective distribution' means a distribution from an applicable employer plan of all amounts attributable to an erroneous automatic contribution.

`(3) ERRONEOUS AUTOMATIC CONTRIBUTION- For purposes of this subsection, the term `erroneous automatic contribution' means an elective contribution made on behalf of an employee under any applicable employer plan pursuant to a plan provision treating the employee as having elected to have the employer make such elective contribution until the employee affirmatively elects not to have such contribution made or affirmatively elects to make contributions at a specified level, if the following requirements are satisfied:

`(A) Within the applicable period, the employee notifies the plan administrator that the employee elects to have the elective contribution treated as an erroneous automatic contribution.

`(B) The sum of the elective contributions that are treated as erroneous automatic contributions with respect to an employee does not exceed $500.

`(4) APPLICABLE EMPLOYER PLAN- For purposes of this subsection, the term `applicable employer plan' has the meaning given such term by subsection (v)(6)(A).

`(5) APPLICABLE PERIOD- For purposes of this subsection, the term `applicable period' means, with respect to an employee, the 3-month period that begins on the first date that an amount is withheld from compensation payable to the employee in order to make a plan contribution pursuant to a plan provision described in paragraph (3).'.

(2) VESTING CONFORMING AMENDMENTS-

(A) INTERNAL REVENUE CODE OF 1986-

(i) Section 411(a)(3)(G) of such Code is amended by inserting `an erroneous automatic contribution under section 414(w),' after `402(g)(2)(A),'.

(ii) The heading of section 411(a)(3)(G) of such Code is amended by inserting `OR ERRONEOUS AUTOMATIC CONTRIBUTION' before the period.

(iii) Section 401(k)(8)(E) of such Code is amended by inserting `an erroneous automatic contribution under section 414(w),' after `402(g)(2)(A),'.

(iv) The heading of section 401(k)(8)(E) of such Code is amended by inserting `OR ERRONEOUS AUTOMATIC CONTRIBUTION' before the period.

(B) EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974- Section 203(a)(3)(F) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1053(a)(3)(F)) is amended by inserting `an erroneous automatic contribution under section 414(w) of such Code,' after `402(g)(2)(A) of such Code,'.

(h) Effective Date-

(1) IN GENERAL- Except as provided in paragraph (2), the amendments made by this section shall apply to plan years beginning after December 31, 2005.

(2) SECTION 403(b) CONTRACTS- The amendments made by subsection (e) shall apply to years beginning after December 31, 1998.

(3) REGULATIONS- Final regulations under section 404(c)(4)(B)(iii) of the Employee Retirement Income Security Act of 1974 (added by this section) shall be issued no later than 6 months after the date of enactment of this Act.

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