Intro to the 401(k)
A 401(k) is a retirement plan that deducts employee contributions directly from their payroll to their retirement account. Often the 401(k) will include both traditional and Roth options. People confuse 401(k) plans with other retirement plans or accounts. There are some characteristics make 401(k)s a unique and powerful employee benefit. 401(k)s are not for every company. Like so many other aspects of life- added flexibility brings with it added costs, responsibilities, and complexities. A good team of professionals can help you simplify things.
Basics of 401(k)s
You can break up a 401(k) into 3-pieces: TPA, recordkeeper, and advisor.
Third-Party Administrator (TPA)
Some of the TPA's duties can include:
- Plan compliance testing
- Help with plan design
- Creating and updating plan documents
- Helping prepare IRS forms
- Staying up to date with changes in 401(k) law
It's important to remember that 401k plans have governing documents called plan documents. Though there are a lot of options and flexibility in a 401k plan, you cannot change how it is administered without first making amendments to the plan documents reflecting the changes.
Some of the recordkeeper's duties can include:
- Accounting of the plan and its participants
- Maintaining the 401(k) website
- Tracking and investing contributions for participants
- Storing participant investment elections.
The recordkeeper is probably the most easily recognized by the employer and plan participants since it often provides the website participants to log in to make account changes. Sometimes the recordkeeper and TPA will be the same company; these structures are "bundled" plans.
Not all plans have a financial advisor, but it can be very beneficial to have one. Here are some of the responsibilities an advisor can have.
- Recommend and monitor investments
- Provide plan reviews
- Help with plan compliance
- Offer participant education
- Offer fiduciary service
There are a lot of advisors out there. Some focus on 401k plans, but many focus on personal financial planning. You should find an advisor that has experience with 401k plans.
Employee Contribution Maximums
$19,500 or $26,000 for those over 50-year-old for 2020. The cap for the employee contribution and match is $57,000, or 100% of employee compensation. For those over 50, the limit is $63,500. The maximum contribution limits change almost yearly to account for inflation. Once again, these numbers are for 2020.
Contributions and Benefits Must Not Discriminate
The plan cannot discriminate in favor of highly compensated employees. Because of this, there are multiple tests that a TPA (third-party administrator) runs to ensure the plan is not discriminating in favor of the highly compensated.
Generally, employees must be allowed to participate if they meet two of the following.
- Reach age 21
- Complete 1-year of service
Employers can be less restrictive if they want.
401(k) plans don't have to offer a match unless it is a Safe-Harbor plan. There is a lot of flexibility in how it can be structured. Once again, it's important to stress that the plan documents dictate this.
A participant's contributions to a retirement plan are always theirs to take with them if they leave employment. Vesting schedules can be added to a 401k plan on the company contributions. Some plan structures require 100% vesting. Here are two common types of vesting
- Cliff vesting: the employer contributions don't vest at all until a specific time of service.
- Graded vesting: a percentage of the employer contribution is vested annually until a certain amount of years of service.
Does a 401(k) Make Sense for Your Company?
If you are looking for specific structures, eligibility rules, design flexibility, and vesting, a 401(k) might make sense for your company.
- A variety of investment options
- Vesting schedules options for employer contributions
- Flexible eligibility rules (more so than some other plans)
- Higher contribution limits
- Several matching options
- Traditional and Roth options available
- Contributions are tax-deductible
- Generally higher admin costs
- Added administration duties
- Filing requirements
- Plan testing
- Plan audits (for larger companies)
Talk to a professional to make sure you understand all your options. Please reach out to us. If you are looking for guidance in choosing a retirement plan, we would love to help.