The Dreaded 401(k) Refund: Corrective Distributions

Posted on by Jerome.Pfeffer

 

401K REFUNDS: NOT AS GOOD AS THEY SOUND

With tax season fresh on our minds, many hear the word refund and begin running down their imagery wish list of ways to spend this extra money. However, when it comes to 401(k) refunds, or corrective distributions, the excitement should be dialed back.

Corrective distributions are a headache for plan sponsors and employees alike. Essentially, these refunds mean that your plan has failed testing, and tax deferred money that key employees set aside for retirement has to be returned to them. This is an issue for both you and your employees, in this article we are going to discuss what to do if you fail 401(k) testing and options

HIGHLY COMPENSATED EMPLOYEES

Your workforce is made up of two distinct employee demographics: highly compensated employees (HCEs) and non-highly compensated employees (NHCEs), also known as “rank-in-file”. An HCE is one who owns 5% or more of the company, a direct family member of an owner, or earns more than $120,000 per year and NHCEs make up the remaining portion of your workforce.

These two groups share a common goal of reaching retirement, and although HCEs may be able and willing to contribute more, your plan should be designed with both parties in mind. The IRS requires that both highly compensated plan participants and rank-and-file plan participants contribute to their 401(k) plans at similar rates.

UNDERSTANDING TESTING REQUIREMENTS

If the idea of calculating and comparing percentages send you down a path of traumatic flashbacks of math class, don’t worry. Our goal is to simplify and educate not overwhelm, if you have more questions, we are happy to have that conversation.

ADP TESTING

ADP stands for actual deferral percentage; this test compares the average of salary deferral percentages for HCEs with the average of salary deferral percentages for NHCEs. The ADP test applies to pre-tax and Roth elective deferrals. The purpose of this test is to ensure that all employees are benefitting from the plan. To pass ADP testing, the average contributions of HCEs must not exceed NHCE contribution by a factor of 1.25 or 2 percentage points as illustrated in the chart below:

ACP TESTING

ACP stands for actual contribution percentage test; it is similar to the ADP test, only it tests employer matching contributions. So, ACP only applies to companies that offer a company match. It compares the average of the percentage of matching contributions and after-tax employee contributions for HCEs versus NHCEs.

TOP-HEAVY TEST

Top-Heavy test looks at how much HCEs contribute to the plan compared to everyone else. If Key Employee balances exceed 60% of the entire plan balance at the end of the plan year, the employer is required to make a 3% contribution to the non-key employees to be non-discriminatory.

WHAT IF TESTING FAILS?

401(k) test failures are no fun for anyone, it requires swift action for employers and plan sponsors. To correct plan failures, additional contributions may be required or corrective distributions would need to be made which means pre-tax savings returned requiring owners and key employees to refile their taxes… talk about a nightmare!

CAN TESTING BE AVOIDED?

A Safe Harbor Plan eliminates the need for non-discriminatory testing. They automatically pass ADP/ACP testing when certain contribution and participant notice requirements are met. To fulfill the requirements, employers must make one of the following contributions:

Basic matching – The company matches 100% of all employee 401(k) contributions, up to 3% of their compensation, plus a 50% match of the next 2% of their compensation.

Enhanced matching – The company matches at least 100% of all employee 401(k) contributions, up to 4% of their compensation (not to exceed 6% of compensation).

A non-elective contribution of not less than 3% of compensation is made by the employer to all eligible employees, regardless of whether they defer under the 401(k) arrangement. The 3% contribution must be set by the plan document and may provide that this contribution be made to only Non-Highly Compensated Employees.

QACA safe harbor match – The QACA safe harbor matching contribution formula is a 100% match

on the first 1% of compensation deferred and a 50% match on deferrals between 1% and 6%;

While a Safe Harbor plan allows owners and highly compensated employees to maximize deferrals, they do require specified employer contributions, and all contributions are immediately vested. Another factor to consider is distribution of employee communication, plan sponsors are responsible for notifying participants of their plan rights and obligations within 90 days of their plan eligibility date and 30-90 days before the start of each new plan year thereafter.

Infographic: Managing Your Fiduciary Duty

Posted on by Jerome.Pfeffer

Keeping proper documentation is a good way for plan sponsors and fiduciaries to show compliance with applicable laws and regulations. If the Department of Labor (DOL) or Internal Revenue Service (IRS) knocks on your door, there are certain documents that should be complete and on file.

So, what should you have in your fiduciary vault? Download and save our free infographic to review our proper documentation checklist.

DOWNLOAD INFOGRAPHIC

Should we have a retirement plan committee?

Posted on by Jerome.Pfeffer

 

Should we have a retirement plan committee?

If you are an employer or employee who has decision-making authority over your company’s retirement plan, there is a strong chance that you are a 401(k) plan fiduciary.  You have a legal obligation to operate the plan solely in the interests of the plan participants (people with retirement account balances) and their beneficiaries (people who may inherit those retirement account balances).  Additionally, two other primary responsibilities are to manage the plan for the exclusive purpose of providing benefits and paying reasonable plan expenses.[1]

Many HR representatives, Controllers, CEOs, CFOs, and Presidents are unfamiliar with the significant amount of liability to which they are exposed with their duties regarding their company’s 401(k) plan. Establishing a retirement plan committee might be a resourceful cornerstone for the oversight of your company’s retirement plan.

Questions to begin

When considering if a retirement plan committee could be beneficial for your organization, start by asking a few questions:

Plan fiduciaries have a continual and ongoing responsibility to monitor the plan.[2]  Therefore, if there was any hesitation over these questions, maybe it’s time to speak with a professional to learn more.

Setting up a committee

If you believe a committee might be a good way to establish plan accountability, reduce liability exposure, and share the task work responsibility of plan management, here are some next steps to consider.

Helping govern your company’s retirement plan is a big responsibility: you have the power to directly impact future retirement outcomes. It is important to take this role seriously.  By establishing a committee, it might be another way that your company can strive to increase the preparedness of your workforce and place them on the path to a secure retirement!

[1] “Health Plans & Benefits: Fiduciary Responsibly.” United States Department of Labor. 7 Feb 2018

[2] “Tibble et al v. Edison International.” Supreme Court of the United States. 18 May 2015.

[3] “29 U.S. Code § 1027 – Retention of records.” U.S. Code.

Benchmarking Your 401(k) Funds

Posted on by Jerome.Pfeffer

 

BENCHMARKING YOUR 401(K) FUNDS

Benchmarking is a retirement plan best practice that allows plan sponsors the opportunity to “take a peak under the hood” of their 401(k). The process allows you to compare your plan to similar plans, measuring key metrics such as participant saving and participation rates, fee reasonableness and service providers. Benchmarking should be a key part of your due diligence process and there are four main areas to focus on when assessing your company’s retirement plan.  They are:

  1. Plan Design
  2. Service Providers
  3. Funds
  4. Fees

Each aspect of your plan requires a slightly different set of research, analysis, questions and documentation process.  In this article, we are going to focus on the best practice of benchmarking Funds.

FUNDS

To get started, let’s use a familiar analogy.  If your company’s retirement plan was a car, then the plan’s investments would be like the components and features of your vehicle.  They would range from the engine and power steering, to features like back-up camera, cruise control, power windows, Bluetooth, and more.  The features you select will depend on your preference and driving needs.  However, for now, let’s begin with the basic car model – or in the 401(k) world, we call these investment menu options the 404(c) list of funds.

The basic 401(k) investment menu would include five (5) investment categories:

In the car industry that would be like the equivalent of:

While all of these are necessary for the car to run, there are always options with each selection. Just like a car, your investment menu may offer different types of investment categories. While searching for appropriate investments for your plan, it is a best practice to speak with an investment professional for support.  They can help to find, narrow, and provide a list of investment options that aim to meet the objectives of the plan and diversity of the participants.

With the basic mechanics of your 404(c) list established, it’s time to actively monitor, or benchmark, them.

Benchmarking best practices:

Additionally, it’s important to remember that each participant has a different retirement time horizon and risk appetite.  Therefore, when plan fiduciaries are selecting the investments for the plan, it’s important to consider different investment options that are in the best interest for the variety of the employee population.

One investment option to consider is a qualified default investment alternative, better known as a QDIA. This is a particular investment fund that encourages employees to invest in long-term savings options. Adopting a QDIA can help plan sponsors manage exposure to liability from the investment decisions (or lack thereof) made by their plan participants. Without one, fiduciaries could be held liable for losses when a participant fails to actively direct their investment.

QDIA regulation states that plan participants have exercised control over the assets in their retirement accounts if, in the absence of a participant’s investment instructions, the plan sponsor invests those assets in a QDIA. This serves as a safe harbor for the plan sponsor. There are four different types of approved QDIA funds:

Target date fund: Creates an investment model based on participant’s age, retirement date and life expectancy.

Balance fund: Offers a mix of equity and fixed income investments.

Professionally managed account: This is actively managed by investment managers and provides an appropriate asset mix of equities and fixed income for each individual participant; this also takes into account the primary decision factors of age, retirement date, and life expectancy.

Stable value fund: This serves as a capital preservation product for the first 120 days of participation and offers an option for plan sponsors who want to simplify administration if employees opt out of participating before incurring additional tax.

Take the time to document each investment.  Also, if you have questions or want to talk through strategies, we can help.

A key goal of a retirement vehicle is to provide employees with a suitable vehicle that, like a car, can fuel their drive toward a successful retirement destination.

VIDEO: CREATING A REPEATABLE 401(k) FIDUCIARY PROCESS

Posted on by Jerome.Pfeffer

Being apart of your company’s retirement plan committee is a big responsibility with some important rules and regulations.

We want to help you to create a repeatable process for your committee. Take a look at our short video that breaks down a simple, yet effective process to help manage your company’s retirement plan and help each employee reach their retirement goals.

INFOGRAPHIC: HOW MUCH SHOULD I SAVE?

Posted on by Jerome.Pfeffer

If you have a company 401(k) plan, your plan participants defer a percentage of their paycheck to their 401(k). However, there are many different factors that go into how much they can actually contribute based on their personal finance goals.

Ask them, “What is your GOAL? Check out our infographic to analyze and prioritize your financial goals!”

ITEMS YOUR ANNUAL RETIREMENT PLAN REVIEW MAY BE MISSING

Posted on by Jerome.Pfeffer

 

As a plan sponsor, you are no stranger to the annual retirement plan review. And believe it or not, it is that time of year again! Although you may meet quarterly or semi-annually with your advisor, a yearly plan assessment is an opportunity to evaluate the health of your plan.

Many times, the focus of an annual review has to do with investments and fund line-ups; and while this is important and should absolutely be addressed, your review should go further. In this article, we are going to discuss a few not-so-common items to add to your annual plan review checklist.  Your review should assess five major areas: plan design, retirement readiness, fiduciary oversight, service provider due diligence, and investment due diligence.

PLAN DESIGN

When discussing plan design, it is important to evaluate 3 key demographics: participation rate, deferral rate and diversification. If your plan suffers from low participation and deferral rates, as well as poor participant driven investment decisions, you are not alone.

Participation Rates[1]                     Deferral Rates1                            Diversification1

90% (Auto-enrollment)                    10-15% (Industry recommendation)                           90% (Balanced Investment Strategy)*

79% (Voluntary Enrollment)            6.2% (Average Deferral Rate)                                              *For those Auto-enrolled

Assessing your company’s annual rates could shine light on auto features that may enhance your plan design. Implementing options such as auto-enrollment, auto-escalation, and target-date or QDIA defaults may combat the common obstacles mentioned above.

RETIREMENT READINESS

At the end of the day, the purpose of your plan is to prepare your employees for their ultimate goal of retirement. The design of your plan can help your participants prepare via defaults and automatic features, but can you do more to motivate and educate them?

FIDUCIARY OVERSIGHT

Your annual review is a great opportunity to pop open your fiduciary vault to organize, review and update your plan documents. The documents may include:

SERVICE PROVIDER DUE DILIGENCE

While assessing the fees and services that each service provider offers, don’t forget to ask about new services and technologies. Tech develops quickly these days and your service providers may have updated websites, mobile apps and reporting software. Ask what is new and developing and if it has an impact on plan fees.

Another question you may consider is how the fiduciary rule may affect your vendor relationships and if there are any conflicts of interest they need to disclose. Although the date for the rule’s implementation hangs in the balance, as a fiduciary, these are questions you should be asking.

INVESTMENT DUE DILIGENCE

One of the costliest fiduciary missteps you can make is having an Investment Policy Statement (IPS) not following it. It was listed previously in the fiduciary oversight section, but is well worth another mention.

A, I, R, S, B, C, F. Listing the options for investment share classes may look like the letters you select during a Wheel of Fortune bonus round; but, they do matter and should be discussed during your annual meeting.

LOOKING AHEAD

It is just as important to look ahead during your annual review as it is to look back on the previous year. Use this opportunity to set goals for the plan and put them on a timeline. Consider adding them to your quarterly or semi-annually meeting agendas to help you stay on track.


Securities and Advisory Services Offered Through LPL Financial. A Registered Investment Adviser. Member FINRA / SIPC.

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. This material was prepared for Jerome Pfeffer’s use.

For Plan Sponsor Use Only – Not for Use with Participants or the General Public.

[1] Vanguard. “How America Saves.” June 2017.

INFOGRAPHIC: PLAN SPONSOR PLAN QUESTIONNAIRE

Posted on by Jerome.Pfeffer

Your annual retirement plan review has many different layers to it and presents the opportunity to evaluate the overall health of your plan.

Utilize our free checklist to review key questions for fiduciary compliance, plan design, retirement readiness, fiduciary oversight, service provider due diligence, and investment due diligence.

MOTIVATING SAVINGS WITH FINANCIAL WELLNESS AND PLAN DESIGN

Posted on by Jerome.Pfeffer

 

Resolution season is upon us. January through March are the peak motivation months.  That special time of the year when people are eager to make positive strides toward physical, financial, professional, or personal goals.  On average, 42% of Americans make money-related resolutions.  However, in less than 6 months, half of the once dedicated forget about their goals.[1] But, as we all know, it takes longer than 6 months to reach a meaningful savings goal.

So, how can you, as a plan sponsor, use the resolution momentum to inspire your employees to save for retirement? This article we will discuss holistic ways to promote financial wellness among your employees as well as plan design tips aimed at increasing participation and savings rates.

Employee Savings Goals

We’ve all heard the saying, “if you don’t know where you’re going, any road will get you there.” However, without a financial goal, many are left unprepared and money has a way of slipping away when there is no clear savings path.

As a retirement plan advisor, my job would be so much easier if every one of your employees were focused on saving for retirement; but the reality is, if they are financially stressed, retirement is the last thing on their minds. Depending on the age and financial situation of your workforce, top concerns may range from meeting monthly expenses, to paying off debt or saving for college, to caring for aging parents. It’s important to understand that saving is a journey and even though each of your employees may be in a different spot, however, the act of saving needs to be constant.

TIP: Encourage your employees to maintain an active list of financial goals. This will help them set a savings path and may help you to determine a more focused financial wellness program or specific education topics.

Savings Buckets

The term savings bucket is not new to you as a plan sponsor, as you may have regular conversations with your recordkeeper about them. However, it may be a brand-new concept for your employees. The three-bucket principal is a way of simplifying the art of saving. First you fill bucket #1 and once it is full, savings begin pouring into bucket #2, then it is on to the final bucket. Each bucket holds savings for a specific goal: Bucket #1 is reserved for Emergency Funds; Bucket #2: The Middle Bucket; Bucket #3: Retirement Bucket.

Bucket #1: Emergency Funds |Bucket #2: The Middle Bucket |Bucket #3: Retirement Bucket

Plan Goals

Beyond the holistic efforts of financial wellness that address the financial hurdles your employees face, there are steps you can take from a plan level that can motivate positive savings habits. Automatic features such as auto-enrollment and auto-escalation are two plan design features that can help you pursue goals of increasing participation and deferral rates.

Auto-enrollment is an excellent plan design feature to help get new hires saving from the get-go. In fact, Vanguard research shows that plans with auto-enrollment boast participation rates reaching 90% whereas plans with voluntary enrollment fall short at 63% participation.[2] You may also consider adding features that enroll (or backsweep) workers who may not have been previously enrolled in your 401(k) plan.

Participating in the plan is great, but you want your employees to be saving at the highest possible rate. One way to help is by implementing an auto-escalation feature. Consider enrolling (or re-enrolling) employees into the plan at a modest 5% savings rate, then increase the deferral by a set percentage each year until a more meaningful rate is reached.  Optional formulas:

Deferral GOAL Starting Deferral Annual Increase Years to Accomplish
10% 5% 1% 5 years
10% 5% 2% 2.5 years
15% 5% 2% 5 years

 

Always Moving Forward

Creating a culture for your employees to save begins with a dialog; we are happy to help with that conversation. At Investment Solutions Group, we feel that employee education and empowerment starts with the plan sponsor. Thus, we aim to provide resources and tools that help you help your employees move toward their savings goals.


Securities and Advisory Services Off ered Through LPL Financial. A Registered Investment Adviser. Member FINRA / SIPC.

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. This material was prepared for Jerome Pfeff er’s use.

For Plan Sponsor Use Only – Not for Use with Participants or the General Public.

[1] Statistic Brain. “New Year’s Resolution Statistics.” Jan. 2017.

[2] Vanguard. “How America Saves.” June 2017.

2018 401(k) COMPLIANCE CALENDAR

Posted on by Jerome.Pfeffer

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