Restating Your Retirement or Defined Contribution Plan: Six Features for Plan Sponsors to Consider
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All prototype and individually designed volume submitter retirement plans are required to be updated and resubmitted to the IRS for review and approval every six years. All of these plans must be restated by April 30, 2016. While this is a requirement, it is also an opportunity to revisit your retirement benefit. The question we ask all plan sponsors during the restatement process is: what are you trying to accomplish with your retirement plan? Based on the answers, we can make recommendations on plan design features.
Here are six features every plan sponsor should consider before restating their plan:
Consider adding automatic enrollment, automatic deferral increase and defaulting participants into a qualified default investment vehicle (QDIA) like a target date fund. Adding automatic features can be especially beneficial if plan participation is low. Automatic enrollment is a great way to increase participation. If the plan already has an automatic enrollment feature, then consider adding automatic deferral rate increase. You may have participants who were defaulted into the plan at 3% and are complacent, disengaged or lack initiative to increase their deferral percentage. By automatically increasing participant deferral rates by 1% each year, you can help them save more. Selecting the proper QDIA, like target date funds, can also relieve the plan sponsor of some fiduciary liability for investment selection.
If you fail your Actual Deferral Percentage/Actual Contribution Percentage or ADP/ACP test, a non-discrimination test required by the IRS, you should also consider automatic features. Automatic enrollment is a good option for plans whose highly compensated employees (HCEs) cannot contribute as much as they want to the plan because the non-highly compensated (NHCEs) are not participating at sufficient rates. Moving to automatic enrollment will increase participation, alleviate your testing issues and allow you stop making refunds to HCEs.
When moving to automatic features, plan sponsor should make sure they have the internal controls to make the features work properly. Can your payroll system or provider automatically enroll employees in a given time period? Can your contributions automatically flow to your plan administrator and be deposited in a timely fashion? This is especially critical for smaller companies and plans.
Many plans added the Roth feature in the last restatement period, but if you have not added this feature, now is the time to reconsider. There is very little, if any cost, to adding the Roth feature for a plan sponsor.
A Roth account allows participants to save after-tax money for retirement. Savings grow tax-free and then at retirement contributions and earnings can be taken out tax-free. While the upfront tax break has always been an attractive feature of saving in a 401(k) account, a Roth account still allows for the tax-free compounding of all earnings – also a nice benefit for employees. Offering both a regular 401(k) and Roth feature offers participants tax diversification. They can contribute to both a pre-tax 401(k) and a Roth 401(k) and then have both taxable and tax free distribution options at retirement. 2
The key to adding the Roth feature is educating employees on the benefits and differences between a pre-tax 401(k) and a Roth contribution. It is common to discuss diversification for investments. Here is an opportunity to educate employees on another type of diversification – tax diversification.
The Roth feature benefits younger employees who have a longer time until retirement. While they will pay taxes on the money up front, compounding those savings tax-free for 20, 30 or even 35 years can add up to a sizeable tax-free retirement income source. If your workforce consists of younger employee then you really should consider adding this feature during the restatement review.
Safe Harbor Plan
Should your plan become a safe harbor plan? This is a good question to consider at restatement time, especially if you are regularly failing your ADP/ACP tests and/or already making a profit sharing or matching contribution. Your current contribution, either match or profit sharing, may already be similar to or exceed the safe harbor contribution requirement. You should consider taking advantage of what a safe harbor plan has to offer. A safe harbor plan may help you eliminate the need to make refunds or allow individuals to save more in the plan with testing issues out of the way. Additionally it will reduce your administrative burden by eliminating the need to perform certain year-end testing.
Revamp Cash-Out Policy
If your plan currently doesn’t have a $5,000 cash out limit then you may wish to consider this policy. When working with employers, we want them to consider adding the $5,000 cash out limit if they have close to 100 participants. Plans with 100 employees or greater require an annual audit. Terminated employees with balances in the plan count as participants and could trigger the administrative burden and expense of an audit. Terminated employees with small balances can be cashed out or rolled over into an IRA to keep the participant account under 100.
Accounts with a balance of $1,000 – $5,000 must be rolled over to an IRA. Accounts with a balance of less than $1,000 can be cashed out by the employer if the participant is located. The check will be minus 20 percent in federal taxes.
The $5,000 cash out limit can also help employers who have a workforce with a higher turnover rate. It can be a burden to the employer to constantly locate terminated employees with low balances.
Review Provisions – Remove Unnecessary Legacy Provisions
If your plan still has a joint and survivor annuity distribution option, you may wish to remove it. It can be burdensome to provide the proper notices, select an annuity provider, and monitor spousal consent, for a feature that is seldom used.
When restating your plan you may also wish to review your loan policy. Most retirement plans have a loan feature. The feature can be attractive to younger employees who want to know they can access their savings if needed. But if your plan offers a second loan or even multiple loans you should examine whether they are worth keeping. The purpose of the plan is to save and having to administer multiple loans can be an administrative burden and detrimental to participants trying to save for retirement.
If your plan does not offer in-service withdrawals at age 59 1/2 you may wish to consider adding this feature. The feature can benefit someone who the company may wish to keep on part-time or who may wish to scale back prior to full retirement. He or she will have access to their retirement savings to supplement their income if needed.3
Review Discretionary Profit Sharing Allocation
You should also review your discretionary profit sharing allocation method to make sure it is in keeping with how you wish to reward individuals at your firm. Here are common allocation methods:
In this allocation method, everyone receives the same amount of profit sharing. This can be an expensive allocation since in order for owners to maximize their contributions eligible employees would need to receive the same contribution amount. This is the least used method.
Social Security Integrated Allocation
This method allows employees making above the wage limit ($118,500 for 2015) a higher profit sharing allocation because their compensation above the limit is not taken into account for Social Security purposes. This plan design allows some favorable treatment of the HCEs in a plan. This is a more common allocation method.
New Comparability (Cross-tested)
This method allows for different percentages of profit sharing for each designated group of employees. This allocation has become very popular. The owners may achieve the maximum allocation by providing up to 5% of contribution to the employees. There is additional non-discrimination testing required, when this allocation is used.
With all of these allocation methods the questions you need to ask yourself are: what is the plan trying to accomplish with the profit sharing allocation? Who will benefit? Plan census data can be used to perform a cost benefit analysis to determine the approach that will best achieve a plan’s goals.
As you review your documents, consider these six features to help make the most of your retirement benefit. It will also keep you from running afoul of the regulations. Failure to keep plan documents up to date and in compliance could result in plan disqualification, taxes and penalties. The priority is to create a retirement plan that best serves your company and employees.