As a company that works with both individual and institutional investing, we try to send out information that could be useful for both types of clients. For instance, our posts on diversification, emotional investing, and long-term investing can give guidance to any investor! But every now and then we will focus on specific topics, dedicated to one type of investing. Today is one of those days. Today’s blog post will hopefully help our 401(k) Providers gain some clarity in the midst of paperwork and regulations.
The paperwork involved in a 401(k) plan can seem tedious and overwhelming, but there are actually six easy steps to understanding it all. Once these decisions are made, hand them off to a professional 401(k) plan provider and have that person write up a detailed plan that reflects your decisions.
First, there is the matter of eligibility. Who qualifies for your plan? Can new employees enter the plan automatically when hired? Or is there a minimum age requirement? Choose when you will allow new plan entries- will it be monthly, quarterly, or semi-annually?
Second is the matter of compensation.The law allows you to exclude certain types of compensation, such as that earned before plan entry or fringe benefits. If special annual testing is passed, bonuses and overtime can be excluded. Make sure to be clear on what types of compensation are included in your plan.
Third comes the assessment of contributions. 401(k) plans permit both employee and employer contributions. All employer contributions have to be placed in participant accounts based on the formula decided upon in the plan document. There are four types of contributions to be considered:
a. Employee Contributions
401(k) plans are based on a plan that receives pre-tax contributions instead of receiving that money in the form of a cash payment now. If automatic enrollment is chosen then all employees can be enrolled, as long as they have the option to “opt out” of contributing to the plan.
b. Safe Harbor Contributions
A safe harbor 401(k) plan automatically satisfies the ADP/ACP testing requirements, as well as automatically satisfying minimum contribution requirements when there are no profit sharing contributions. Eligible safe harbor contributions would include: 4% matching contribution, 5% matching contribution (QACA safe harbor plans only), 3% non-elective contribution. These are all mandatory contributions, subject to 100% vesting, and may not be subject to allocation conditions.
c. Matching Contributions
Each year the match rate can be determined based upon the elective deferrals made by participants. If the matching contribution is funded after the end of the year, participants can be required to satisfy certain allocation conditions in order to receive a contribution.
d. Non-Elective (Profit Sharing) Contributions
In this type of contribution the employer has the flexibility to determine the contribution amount annually. The employer is then able to contribute more when there are high profits and less when business is struggling, without having to amend the plan’s contribution formula.
The fourth part of 401(k) plans to be considered is vesting. When a participant removes themselves from the program they are entitled to the vested portion of their account balance. The rest must be forfeited to the plan. These forfeited portions can then be used to pay plan expenses or reduce future employer contributions. Most safe harbor contributions must always be 100% vested immediately and participants are required to become 100% vested when they reach retirement age.
Fifth in line is the matter of distributions. Many times plans only permit a lump sum distribution when a participant is released from service and required to receive a distribution. With the lump sum option, the participants must take their entire vested account balance in a single distribution, rather than the other forms available, such as installment plans.
And finally, the last part of the plan to be considered is loans. Loans can be allowed or disallowed. Though they are popular with employees, it can complicate administration for the employer.
We hope that this overview has been helpful! Please contact us with any further questions you might have.