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Business Owners, Know These 401(k) Plan Red Flags

Business Owners, Know These 401(k) Plan Red Flags

March 20, 2024

Beware of common mistakes employers may overlook when offering retirement plans.

Offering a retirement plan to your employees is an ideal recruiting and retention tool. But, how does your retirement plan stack up? Are you aware of some of the hazards your plan could be harboring? Here are some key red flags to look out for in your retirement offerings.

 

Are your fees reasonable?

Plenty of small business owners don’t even know how much they’re paying to offer their 401(k), and rates can vary widely. A small company with 10 employees might pay as little as $1,400 or as much as $5,600 to set a plan up and keep it operating for a year. A larger company might pay more … or, thanks to economies of scale, might pay less.

Different plans can also hide fees for services like rolling over funds from other retirement accounts, integrating the plan into your payroll system, amending your plan design after it’s already set up, and administering loans or withdrawals. Whether it’s you or your workforce who get the surprise, discovering an unexpected fee can leave a bad taste in your mouth.

 

Are you getting credit for your plan?

You can even get money back from the plan you set up for your small business. Under the SECURE Act. small businesses with less than 100 employees can get tax credits up to $5,000 annually for three years when starting up a new 401(k).

 

Are you getting the most for your match?

For employees, this means “How much does your employer contribute your retirement fund?” Most companies match contributions up to between 4% and 6% of each paycheck.

For employers, though, this means you could be streamlining your systems (and saving the associated costs) if your matches qualify your plan as a “safe harbor” 401(k). A safe harbor plan doesn’t have to do any non-discrimination compliance testing, which is otherwise an annual headache. 

There are four ways to do matching that earns this status:

  • a “basic” safe harbor that matches 100% of the first 3% of employee’s contributions, then 50% on the next 2%;
  • an “enhanced” plan that matches 100% of the first 4% of an employee’s contribution;
  • a “non-elective” plan that gives every eligible employee a 3% contribution regardless of if they enroll in the plan;
  • or a “qualified automatic contribution arrangement” (or QACA). The QACA must be set up to automatically contribute 3% of an employee’s pay for the first year of participation, then boost that to 4% in the second year, 5% in the third, and 6% in the fourth … and the employer must match 100% of the first 1% of an employee’s contribution plus 50% on the next 5% for a maximum of 3.5% of pay on the first 6% of any employee’s contribution.

Running a plan with safe harbor matching lowers your administration costs, and also eliminates the risk of failing one of the annual non-discrimination tests (there are three). Otherwise, a failure means you get a refund of your excess contributions, which makes your taxable income higher and your savings lower, and you’ll possibly need to make a 3% contribution to all non-owners, which as you can imagine can add up quickly.

 

Are you offering a good variety of investments?

Seasoned investors know the importance of a diversified portfolio — especially when it comes to something as long-term as a retirement plan. A good 401(k) gives employees choices for where their contributions go, whether it’s in municipal bonds, small-cap businesses, tech funds, or mutual funds offering stocks in tried-and-true major American corporations. Employees respond well to good choices, and even better when flexibility makes it easy to shift investments as the market changes. A financial adviser can help you determine if your selection measures up to industry standards.

 

Are you on top of your fiduciary responsibilities?

Like it or not, offering a 401(k) plan gives you a taste of what it’s like to be an investment advisor. Setting up the plan is a business decision, but deciding how it works is a fiduciary decision, and fiduciaries have their own legal responsibilities … even if you’re hiring someone else to administer your plan. As the U.S. Bureau of Labor puts it, “Hiring someone to perform fiduciary functions is itself a fiduciary act.”

Responsibilities include the need to be prudent (offering a diverse, balanced portfolio of investments) and timely (getting deposits in by no later than the 15th business day of the month following the payday, or in a company with fewer than 100 employees, no later than the 7th day). Your plan’s fiduciary has a legal responsibility to act solely in the interest of the participants and their beneficiaries, exclusively provide benefits to workers participating in the plan and their beneficiaries, pay only reasonable plan expenses, adhere to the plan documents, and use the care, skill, and diligence of a professional.

The fiduciary will also have to be aware of changes of the law (like recent updates to the SECURE Act) and amend the plan’s documents accordingly.

Having a qualified financial advisor in this role — or having your trustee regularly consult with an advisor — can be a big help.

 

Is your I.R.S. housekeeping in order?

The Internal Revenue service has a handy checklist for 401(k) maintenance, which includes entries like “Was Form 5500 filed?” (referring to your annual return), “Are elective deferrals limited to the IRC Section 402(g) limits for the calendar year?” (referring to contributions meant to be excluded from taxable income) and “Is the plan’s definition of ‘compensation’ for all deferrals and allocations used correctly?” (because “compensation” can mean wages, but also tips, bonuses, commissions, and other perks … and only 15% of that compensation can be excluded from taxes). There are plenty of other questions like these, and if some of them aren’t in order, it can mean fines or worse. A financial advisor with experience in I.R.S. regulations can help navigate the ins and outs.

 

What’s next? Get a plan review!

If you’ve got questions about any of these red flags, or anything else to do with your company’s 401(k), we’ve got articles, videos, calculators, and other resources here, or you can schedule a consultation with one of our advisors for a closer look at what you need to get the most out of your plan.

 

Sources:
How to offer a plan: https://www.hmc-partners.com/blog/business-owners-do-you-know-how-to-offer-a-401k-plan

Safe Harbor: https://www.completepayrollsolutions.com/blog/safe-harbor-401k-plans

Bureau of Labor: https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/401k-plans-for-small-businesses.pdf