401k Plan Setup

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What is a 401(k) QDIA?
A QDIA (Qualified Default Investment Alternative) is the plan’s default investment. When money ...
What is a 401(k) QDIA? A QDIA (Qualified Default Investment Alternative) is the plan’s default investment. When money is contributed to the plan, it’s automatically invested in the QDIA. What is a QDIA? A 401(k) QDIA (Qualified Default Investment Alternative) is the investment used when an employee contributes to the plan without having specified how the money should be invested. As a "safe harbor," a QDIA relieves the employer from liability should the QDIA suffer investment losses. Here’s how it works: When money is contributed to the plan, it’s automatically invested in the QDIA that was selected by the plan fiduciary (typically, the business owner or the plan sponsor). The employee can leave the money in the QDIA or transfer it to another plan investment. When (and why) was the QDIA introduced? The concept of a QDIA was first introduced when the Pension Protection Act of 2006 (PPA) was signed into law. Designed to boost employee retirement savings, the PPA removed barriers that prevented employers from adopting automatic enrollment. At the time, fears about legal liability for market fluctuations and the applicability of state wage withholding laws had prevented many employers from adopting automatic enrollment—or had led them to select low-risk, low-return options as default investments. The PPA eliminated those fears by amending the Employee Retirement Income Security Act (ERISA) to provide a safe harbor for plan fiduciaries who invest participant assets in certain types of default investment alternatives when participants do not give investment direction. To assist employers in selecting QDIAs that met employees’ long-term retirement needs, the Department of Labor (DOL) issued a final regulation detailing the characteristics of these investments (see What kinds of investments qualify as QDIAs? below). Why does having a QDIA matter? When a 401(k) plan has a QDIA that meets the DOL’s rules, then the plan fiduciary is not liable for the QDIA’s investment performance. Without a QDIA, the plan fiduciary is potentially liable for investment losses when participants don’t actively direct their plan investments. Plus, having a QDIA in place means that employee accounts are well positioned—even if an active investment decision is never taken. If you select an appropriate default investment for your plan, you can feel confident knowing that your employees’ retirement dollars are invested in a vehicle that offers the potential for growth. Does my retirement plan need a QDIA? Yes, it’s a smart idea for all plans to have a QDIA. That’s because, at some point, money may be contributed to the plan, and participants may not have an investment election on file. This could happen in a number of situations, including when money is contributed to an account but no active investment elections have been established, such as when an employer makes a contribution but an employee isn’t contributing to the plan; or when an employee rolls money into the 401(k) plan prior to making investment elections. It makes sense then, that plans with automatic enrollment must have a QDIA. Are there any other important QDIA regulations that I need to know about? Yes, the DOL details several conditions plan sponsors must follow in order to obtain safe harbor relief from fiduciary liability for investment outcomes, including: A notice generally must be provided to participants and beneficiaries in advance of their first QDIA investment, and then on an annual basis after that Information about the QDIA must be provided to participants and beneficiaries which must include the following: An explanation of the employee’s rights under the plan to designate how the contributions will be invested; An explanation of how assets will be invested if no action taken regarding investment election; Description of the actual QDIA, which includes the investment objectives, characteristics of risk and return, and any fees and expenses involved Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as other plan investments, but at least quarterly For more information, consult the DOL fact sheet. What kinds of investments qualify as QDIAs? The DOL regulations don’t identify specific investment products. Instead, they describe mechanisms for investing participant contributions in a way that meets long-term retirement saving needs. Specifically, there are four types of QDIAs: An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (for example, a professionally managed account like the one offered by Betterment) A product with a mix of investments that takes into account the individual’s age or retirement date (for example, a life-cycle or target-date fund) A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (for example, a balanced fund) The fourth type of QDIA is a capital preservation product, such as a stable value fund, that can only be used for the first 120 days of participation. This may be an option for Eligible Automatic Contribution Arrangement (EACA) plans that allow withdrawals of unintended deferrals within the first 90 days without penalty. We’re excluding further discussion of this option here since plans must still have one of the other QDIAs in cases where the participant takes no action within the first 120 days. What are the pros and cons of each type of QDIA? Let’s breakdown each of the first three QDIAs: 1. An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date Such an investment service, or managed account, is often preferred as a QDIA over the other options because they can be much more personalized. This is the QDIA provided as part of Betterment 401(k)s. And Betterment factors in more than just age (or years to retirement) when assigning participants to one of our 101 core portfolios. We utilize specific data including salary, balance, state of residence, plan rules, and more. And while managed accounts can be pricey, they don’t have to be. Betterment’s solution, which is just a fraction of the cost of most providers, offers personalized advice and an easy-to-use platform that can also take external and spousal/partner accounts into consideration. 2. A product with a mix of investments that takes into account the individual’s age or retirement date When QDIAs were introduced in 2006, target date funds were the preferred default investment. The concept is simple: pick the target date fund with the year that most closely matches the year the investor plans to retire. For example, in 2020 if the investor is 45 and retirement is 20 years away, the 2040 Target Date Fund would be selected. As the investor moves closer to their retirement date, the fund adjusts its asset mix to become more conservative. One common criticism of target date funds today is that the personalization ends there. Target date funds are too simple and their one-size-fits-all portfolio allocations do not serve any individual investor very well. Plus, target date funds are often far more expensive compared to other alternatives. Finally, most target date funds are composed of investments from the same company—and very few fund companies excel at investing across every sector and asset class. Many experts view target date funds as outdated QDIAs and less desirable than managed accounts. Morningstar, a global investment research company, discusses the pros and cons of managed accounts versus target date funds, and predicts that they may become obsolete over time. 3. A product with a mix of investments that takes into account the characteristics of the group of employees as a whole This kind of product—for example, a balanced fund—offers a mix of equity and fixed-income investments. However, it’s based on group demographics and not on the retirement needs of individual participants. Therefore, using a balanced fund as a QDIA is a blunt instrument that by definition will have an investment mix that is either too heavily weighted to one asset class or another for most participants in your plan. Better QDIAs—and better 401(k) plans Betterment provides tailored allocation advice based on what each individual investor needs. That means greater personalization—and potentially greater investment results—for your employees. At Betterment, we monitor plan participants’ investing progress to make sure they’re on track to reach their goals. When they’re not on target, we provide actionable advice to get them back on the road to investment success. As a 3(38) investment manager, we assume full responsibility for selecting and monitoring plan investments—including your QDIA. That means fiduciary relief for you and better results for your employees. All of this for a fraction of the cost of most providers. The exchange-traded fund (ETF) difference Another key component that sets Betterment apart from the competition is our exclusive use of ETFs. Cost-effective, highly flexible, and technologically sophisticated, ETFs are rapidly gaining in popularity among retirement investors. Here’s why: Low cost—ETFs generally cost far less than mutual funds, which means more money stays invested Diversified—All of the ETFs used by Betterment are well-diversified so that investors are not overly exposed to individual stocks, bonds, sectors, or countries—which may mean better returns in the long run Sophisticated—ETFs take advantage of decades of technological advances in buying, selling, and pricing securities. Learn more about these five attributes now. Helping your employees live better Our mission is simple: to empower people to do what’s best for their money so they can live better. Every aspect of our solution from our QDIAs to our user-friendly investment platform is designed to give your employees a more personalized, holistic experience. We invite you to learn more about what we can do for you. -
Pros and Cons of Safe Harbor and Traditional 401(k) Plans
Both types of plans can successfully help employees save for retirement, but each has its pros ...
Pros and Cons of Safe Harbor and Traditional 401(k) Plans Both types of plans can successfully help employees save for retirement, but each has its pros and cons. Learn which type of plan might be better for your organization. Employers who are considering offering a 401(k) plan must balance how to help employees save for retirement in a cost-effective manner with the critical administrative considerations including how to ensure the plan operates in a compliant manner and retains its tax-qualified status. At a high level, there are two types of 401(k) plans: the Safe Harbor 401(k) Plan and the Traditional 401(k) Plan. Both types of plans can successfully help employees save for retirement, but each has its pros and cons. Learn which type of plan might be better for your organization. Traditional 401(k) Plans Traditional plans can be cost-effective but must pass certain testing mandated by the IRS. Pros: Employee Incentive - A 401(k) plan is one of the most important benefits that employees look for while exploring their career options. And it comes with significant tax advantages in helping employees save for their future. Cost-Effectiveness - Because there are no required employer contributions, traditional plans may be more cost-effective for the company. Discretionary Contribution - Plan sponsors can decide to match employee contributions or make profit sharing contributions on a discretionary basis, which provides significant flexibility. Each year, employers can choose how much they would like to contribute, or whether they want to contribute at all. Cons: Required Annual Testing - Traditional plans are subject to all compliance tests, including the ADP, ACP and top heavy determination. If one or more of these tests fail, the plan sponsor is subject to corrective actions which can include additional contributions on behalf of the employees. Limits of Contributions for Employees - Because of the ADP test, highly-compensated employees (HCEs) may not be able to maximize their 401k contributions. If HCEs do contribute the maximum amount, and the plan fails the ADP test, required refunds may increase taxable income for certain HCEs. Administrative Burden - The required tests and possible failures may lead to uncomfortable conversations with employees who are impacted by such failures. They will need to understand why they are receiving refunds of their contributions and may not be able to maximize their 401(k). Safe Harbor 401(k) Plans Safe Harbor plans may be a better choice for employers looking for ways to bypass certain compliance tests. In return for the “safe harbor” status, employers are required to make employer contributions. Pros: Annual testing exemption — A safe harbor plan will be automatically deemed to pass some of the crucial compliance tests such as the ADP and ACP tests, as well as the top-heavy test. Maximize contributions — Because they can bypass certain compliance tests, everyone in the plan can maximize their contributions to the allowable IRS limits, without having to worry about refunds. Taxable income reduced — Employer contributions made as part of the Safe Harbor plan design are tax-deductible, reducing the employer’s taxable income. Improved employee retention — The required mandatory employer contributions mean the 401(k) plan will be an attractive benefit to employees, which can help attract and retain talent and encourage healthy plan participation. Cons: Cost of annual contributions — Safe Harbor plans require mandatory employer contributions on behalf of employees. The employer must be able to provide these contributions every pay period or at the end of the plan year. Failure to do so may result in the plan losing its tax-qualified status. Immediate vesting requirement — Safe harbor contributions must be immediately vested. Once an employer contribution is deposited into an employee’s account, the employee is 100% owner of that money. Annual requirements — A Safe Harbor notice must be delivered to all plan participants every year, at least 30 days prior to the plan year-end. What is the deadline to adopt a safe harbor 401(k) plan for the 2021 plan year? If you are looking to implement a safe harbor plan for the 2021 plan year, it must be live by October 1, 2021. Sign up with Betterment by August 2, 2021 to start reaping the benefits of a safe harbor plan this plan year! Which to choose: Traditional or Safe Harbor 401(k)? The “right” plan for any given organization depends on many factors. The table below provides some insight into which plan design may be more helpful for any given factor, but each organization will need to make its own determination. Betterment is happy to assist with this process. Traditional Safe Harbor Explanation Employee Count 30 + employees Any plan size With few employees, even a small number of HCEs contributing at a relatively high level may make it difficult for plans to pass testing. In addition, the required employer contribution may be more manageable. Employee Demographic Employee base consists largely of full-time employees; Low turnover rate Stable headcount Employee base includes a large number of part-time and/or seasonal employees working <500 hours a year Part-time/seasonal employees are excluded from the plan Safe Harbor plan design is helpful if the employee base is more fluid, which may make it more difficult to ensure the plan will pass testing each year. Participation High (current or expected) participation and contribution rates among the general employee population Owners and officers looking to maximize 401(k) contributions every year With Safe Harbor, owners and offers can maximize contributions without having to worry about potential refunds. Company Cash Flow Less predictable cash flow year over year Consistent and adequate cash flow Since Safe Harbor plans require employer contributions, consistent and adequate cash flow is needed. Previous Compliance Result Passed ADP/ACP Test Deemed not “Top Heavy” Failed ADP/ACP Test Deemed “Top Heavy” Safe Harbor plan design bypasses certain compliance tests, so “failing” them is no longer a concern. Current/Future Plan Design Lenient or no eligibility requirement Automatic enrollment with a high default rate Strict eligibility requirements (i.e. must work 1,000 hours in 12 months to become eligible); No automatic enrollment (or if offered, low default rate) NHCEs contributing at relatively low contribution rates (or not contributing at all) do not cause issues under Safe Harbor plan design. -
Betterment 401(k) – Bulk Upload Tutorial for Plan Sponsors
Betterment’s bulk upload tool allows you to add multiple employees to your plan quickly. This ...
Betterment 401(k) – Bulk Upload Tutorial for Plan Sponsors Betterment’s bulk upload tool allows you to add multiple employees to your plan quickly. This tutorial outlines best practices and shares helpful tips for using our bulk upload tool effectively. Step-by-step Tutorial Log in to the employee Dashboard Navigate to: employees → add employees → add multiple employees Download the CSV template Open the CSV template using a program like Microsoft Excel, Apple Numbers, or Google Sheets Fill out one row for each employee you want to upload. Use the table below to understand the columns in the template: Column Description First Name The employee’s legal first name No special characters accepted Last Name The employee’s legal last name No special characters accepted Middle Initial Leave blank if the employee doesn’t have a legal middle name Social Security Number The employee’s government-issued Social Security Number If the employee is not a US Citizen, a Social Security Number still needs to be provided Social Security Numbers should be formatted as 123-45-6789 Email Betterment uses email to complete the employee sign-up process and to send employees important plan notifications and updates Date of Birth Date should be formatted as MM/DD/YYYY Employment Status This field accepts the following inputs: active (currently employed) terminated (formerly employed) deceased (deceased) disabled (on disability leave) unpaid_leave (unpaid leave) retired (retired former employee) Date of Hire Date of hire can be up to one year in the future Date should be formatted as MM/DD/YYYY Date of Termination This field is required if Employment Status is terminated, deceased, disabled or retired This field can be left blank for employees who are active or who are on unpaid leave Date of termination can be up to one year in the future Date should be formatted as MM/DD/YYYY Date of Rehire This field is required if Employment Status is active and Date of Termination is set Address Line 1 This field is required for all employees The employee’s residential address cannot be a PO Box If the employee’s address includes a comma, you must put that address within quotation marks Address Line 2 This field can be left blank if the employee’s residential address is only one line City Part of the employee’s residential address State Part of the employee’s residential address State should be written using the official two-letter postal abbreviation Examples: NY, FL, CA, TX 5 Digit ZIP Code Part of the employee’s residential address Eligible This field accepts an input of Y or N If an employee will be hired in the future, you must enter N for Eligible, and enter a date in the Entry on column. This indicates that the employee will become eligible for the plan on the future date you’ve specified. Entry on This field defines the date on which an employee will become eligible for the 401(k) plan This date can be in the past or the future Date should be formatted as MM/DD/YYYY Electronic Access This field accepts an input of Y or N Can this employee receive emails and access Betterment’s website at a computer they use regularly as part of their job? Union Member This field accepts an input of Y or N Is this employee a member of a union? Date Joined Union Required if the employee is a member of a union Date should be formatted as MM/DD/YYYY Can be left blank for non-union employees Participant Type This field accepts the following inputs: primary (all participants who are currently in the plan, whether active, terminated, deceased, disabled, retired, or on leave) beneficiary (beneficiary of a deceased participant) alternate_payee (a person who will be the payee of a divorce or other legal settlement) Deferral Rate If an employee was participating in a 401(k) plan you had with a previous provider, please indicate their contribution rate from that provider. This will be used as their new default rate at Betterment. The employee will be able to log into their account to change this prior to their first contribution with Betterment. Traditional deferral amount and percent cannot both be present. Roth deferral amount and percent cannot both be present. If you’re not switching to Betterment from a previous provider, you can leave this field blank. After you’re done filling out the document, export the file as a CSV. Upload your CSV file to Betterment. If you receive any errors after uploading your file, review the errors and make changes to your CSV file. Re-upload the file to Betterment after making changes. Once your file is accepted without any errors, you’ll be asked to review the names of the newly created employees. This helps ensure that you’re uploading the correct file to your plan. When you’re done reviewing, click the ‘add employees’ button. Next, the upload process will begin. Once your employees have been uploaded, they’ll receive an email inviting them to complete the sign-up process. Finally, check the employees page to make sure there are no outstanding errors that occurred during the employee creation process. Address any errors that may have occurred. You’re all set! All new participant profiles will be visible on the employees page. You can return to the employees page to make changes to an employee’s profile at any time. Frequently Asked Questions Do I have to do anything else? Nope! You’re all set. Betterment will email all required disclosures to your new plan participants. Do I have to send any notices to my employees? No, Betterment will send all notices to your employees automatically via email. When will my employees be alerted? Employees will be notified by email as soon as their account is created. How can my employees join the plan after I upload their information to Betterment? Employees can check their email for an invite from Betterment to complete the sign-up process. My employee has a P.O. Box as their address. Can I use that address with Betterment? No– to comply with regulations for opening accounts, we require a physical address to verify an employee's identity. Betterment will not send physical mail to an employee’s address (unless they opt into paper statements, which is rare); we will only use the address for account verification. Questions? Contact us.
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What are New Comparability Profit Sharing Plans?
What are New Comparability Profit Sharing Plans? This plan design gives small business owners significant flexibility when it comes to profit sharing contribution allocations. To retain their tax-qualified status, 401(k) plans are prohibited from discriminating in favor of key owners, officers, and highly compensated employees. Some small businesses that want to help their employees save for retirement may put off offering profit sharing contributions due to the financial burden of a “pro-rata” allocation compared to what the owners might get. For these types of small businesses, a specific profit sharing plan design may provide the solution. Called new comparability, it allows businesses to remain in compliance while making larger contributions to its older participants, typically owners and highly compensated employees. A Different Testing Approach Most profit sharing plans (i.e., pro rata, integrated plans), are deemed to pass nondiscrimination automatically using the safe harbor approach, while new comparability plans are required to pass the general test to prove its not discriminating against non-highly compensated employees. New comparability allows employees to be segmented into more groups so that owners can be considered separately from, say, non-owner HCEs. In addition, testing is based on projected benefits at retirement that are derived from contributions, rather than on the contributions themselves. This “cross-testing” is a bit of a hybrid approach whereby the 401(k) (a defined contribution plan) is tested as if it were a traditional pension (i.e., defined benefit) plan. Plans using this method are able to pass testing and be compliant because younger NHCEs have more time until retirement, and so their projected benefit based on lower contributions falls within an acceptable range of the projected benefit of older HCEs receiving a larger contribution. Using the new comparability plan design, a plan could, for instance, make 401(k) contributions of 10% to owners and 6% to NHCEs. Or contribute 10% to one owner, 8% to another owner, and 5% to NHCEs. Minimum “gateway requirement” To take advantage of the new comparability profit sharing plan design, the contribution to all NHCEs must be a minimum of: One-third of the highest contribution rate given to any HCE; or 5% of the participants gross compensation Firms Well-Suited to New Comparability The new comparability profit sharing plan design is a good solution for companies with fewer than 50 employees that have a group of older owners and/or HCEs that are important to the success of their organization. Companies that tend to implement this design feature include: Law Firms Medical Practices Accounting Firms Service Companies Plan sponsors interested in this feature can include the profit sharing contribution in their plan documents as discretionary, meaning they are never obligated to make a contribution in any given year. This is helpful, too, since your employee demographics will likely change from year to year and so may your profit sharing allocation decisions. In addition to the benefits that a retirement plan provides to employees, profit sharing plans provide real benefits to small business owners. Profit sharing contributions are tax deductible and not subject to payroll taxes (e.g. FICA). The new comparability profit plan design gives small business owners significant flexibility to offer a 401(k) that meets the needs of their organization. -
Plan Design Matters
Plan Design Matters Thoughtful 401(k) plan design can help motivate even reluctant retirement savers to start investing for their future. Designing a 401(k) plan is like building a house. It takes care, attention, and the help of a few skilled professionals to create a plan that works for both you and your employees. In fact, thoughtful plan design can help motivate even reluctant retirement savers to start investing for their future. How to tailor a 401(k) plan you and your employees will love As you embark on the 401(k) design process, there are many options to consider. In this article, we’ll take you through the most important choices so you can make well-informed decisions. Since certain choices may not be available on the various pricing models of any given provider, make sure you understand your options and the trade-offs you’re making. Let’s get started! 401(k) eligibility When would you like employees to be eligible to participate in the plan? You can opt to have employees become eligible: Immediately – as soon as they begin working for your company After a specific length of service – for example, a period of hours, months, or years of service It’s also customary to have an age requirement (for example, employees must be 18 years or older to participate in the plan). Plus, you may want to add an “employee class exclusion” to prevent part-time, seasonal, or temporary employees from participating in the plan. Once employees become eligible, they can immediately enroll – or, you can restrict enrollment to a monthly, quarterly, or semi-annual basis. If you have immediate 401(k) eligibility and enrollment, in theory, more employees could participate in the plan. However, if your company has a higher rate of turnover, you may want to consider adding service length requirements to alleviate the unnecessary administrative burden of having to maintain many small accounts of employees who are no longer with your organization. Enrollment Enrollment is another important feature to consider as you structure your plan. You may simply allow employees to enroll on their own, or you can add an automatic enrollment feature. Automatic enrollment (otherwise known as auto-enrollment) allows employers to automatically deduct elective deferrals from employees’ wages unless they elect not to contribute. With automatic enrollment, all employees are enrolled in the plan at a specific contribution rate when they become eligible to participate in the plan. Employees have the freedom to opt out and change their contribution rate and investments at any time. As you can imagine, automatic enrollment can have a significant impact on plan participation. In fact, according to research by The Pew Charitable Trusts, automatic enrollment 401(k) plans have participation rates greater than 90%! That’s in stark contrast to the roughly 50% participation rate for plans in which employees must actively opt in. If you decide to elect automatic enrollment, consider your default contribution rate carefully. A 3% default contribution rate is still the most popular; however, more employers are electing higher default rates because research shows that opt-out rates don’t appreciably change even if the default rate is increased. Many financial experts recommend a savings rate of at least 10%, so using a higher automatic enrollment default rate gets employees even more of a head start. Auto-escalation Auto-escalation is an important feature to look out for as you design your plan. It enables employees to increase their contribution rate over time as a way to increase their savings. With auto-escalation, eligible employees will automatically have their contribution rate increased by 1% every year until they reach a maximum cap of 15%. Employees can also choose to set their own contribution rate at any time, at which point they will no longer be enrolled in the auto-escalation feature. For example, if an employee is auto-enrolled at 6% with a 1% auto-escalation rate, and they choose to change their contribution rate to 8%, they will no longer be subject to the 1% increase every year. Compensation You’re permitted to exclude certain types of compensation for plan purposes, including compensation earned prior to plan entry and fringe benefits for purposes of compliance testing and allocating employer contributions. You may choose to define your compensation as: W2 (box 1 wages) plus deferrals – Total taxable wages, tips, prizes, and other compensation 3401(a) wages – All wages taken into account for federal tax withholding purposes, plus the required additions to W-2 wages listed above Section 415 Safe Harbor – All compensation received from the employer which is includible in gross income Employer contributions Want to encourage employees to enroll in the plan? Free money is a great place to start! That’s why more employers are offering profit sharing or matching contributions. In fact, EBRI and Greenwald & Associates’ found that nearly 73% of workers said they were likely to save for retirement if their contributions were matched by their employer. Some of the more common employer contributions are: Safe harbor contributions – With the added bonus of being able to avoid certain time-consuming compliance tests, safe harbor contributions often follow one of these formulas: Basic safe harbor match—Employer matches 100% of employee contributions, up to 3% of their compensation, plus 50% of the next 2% of their compensation. Enhanced safe harbor match—Employer matches 100% of employee contributions, up to 4% of their compensation. Non-elective contribution—Employer contributes 3% of each employee’s compensation, regardless of whether they make their own contributions. Discretionary matching contributions – You decide what percentage of employee 401(k) deferrals to match and the maximum percentage of pay to match. For example, you could elect to match 50% of contributions on up to 6% of compensation. One advantage of having a discretionary matching contribution is that you retain the flexibility to adjust the matching rate as your business needs change. Non-elective contributions – Each pay period, you have the option of contributing to your employees’ 401(k) accounts, regardless of whether they contribute. For example, you could make a profit sharing contribution (one type of non-elective contribution) at the end of the year as a percentage of employees’ salaries or as a lump-sum amount. In addition to helping your employees build their retirement nest eggs, employer contributions are also tax deductible (up to 25% of total eligible compensation), so it may cost less than you think. Plus, offering an employer contribution can play a key role in recruiting and retaining top employees. In fact, a Betterment for Business study found that more than 45% of respondents considered a 401(k) match to be a factor when deciding whether to accept a job. 401(k) vesting If you elect to make an employer contribution, you also need to decide on a vesting schedule (an employee’s own contributions are always 100% vested). Note that all employer contributions made as part of a safe harbor plan are immediately and 100% vested. The three main vesting schedules are: Immediate – Employees are immediately vested in (or own) 100% of employer contributions as soon as they receive them. Graded – Vesting takes place in a gradual manner. For example, a six-year graded schedule could have employees vest at a rate of 20% a year until they are fully vested. Cliff – The entire employer contribution becomes 100% vested all at once, after a specific period of time. For example, if you had a three-year cliff vesting schedule and an employee left after two years, they would not be able to take any of the employer contributions (only their own). Like your eligibility and enrollment decisions, vesting can also have an impact on employee participation. Immediate vesting may give employees an added incentive to participate in the plan. On the other hand, a longer vesting schedule could encourage employees to remain at your company for a longer time. Service counting method If you decide to use length of service to determine your eligibility and vesting schedules, you must also decide how to measure it. Typically, you may use: Elapsed time – Period of service as long as employee is employed at the end of period Actual hours – Actual hours worked. With this method, you’ll need to track and report employee hours Actual hours/equivalency – A formula that credits employees with set number of hours per pay period (for example, monthly = 190 hours) 401(k) withdrawals and loans Naturally, there will be times when your employees need to withdraw money from their retirement accounts. Your plan design will have rules outlining the withdrawal parameters for: Termination In-service withdrawals (at attainment of age 59 ½; rollovers at any time) Hardships Qualified Domestic Relations Orders (QDROs) Required Minimum Distributions (RMDs) Plus, you’ll have to decide whether to allow participants to take 401(k) plan loans (and the maximum amount of the loan). While loans have the potential to derail employees’ retirement dreams, having a loan provision means employees can access their money if they need it and employees can pay themselves back plus interest. If employees are reluctant to participate because they’re afraid their savings will be “locked up,” then a loan provision can help alleviate that fear. Investment options When it comes to investment methodology, there are many strategies to consider. Your plan provider can help guide you through the choices and associated fees. For example, at Betterment, we believe that ETFs offer investors significant diversification and flexibility at a low cost. Plus, we offer ETFs in conjunction with personalized, unbiased advice to help today’s retirement savers pursue their goals. Get help from the experts Your 401(k) plan provider can walk you through your plan design choices and help you tailor a plan that works for your company and your employees. Once you’ve settled on your plan design, you will need to codify those features in the form of a formal plan document to govern your 401(k) plan. At Betterment, we draft the plan document for you and provide it to you for review and final approval. Your business is likely to evolve—and your plan design can evolve, too. Drastic increase in profits? Consider adding an employer match or profit sharing contribution to share the wealth. Plan participation stagnating? Consider adding an automatic enrollment feature to get more employees involved. Employees concerned about access to their money in an uncertain world? Consider adding a 401(k) loan feature. Need a little help figuring out your plan design? Talk to Betterment. Our experts make it easy for you to offer your employees a better 401(k) quickly and easily—all for a fraction of the cost of most providers. -
A Guide to Safe Harbor 401(k) Plans
A Guide to Safe Harbor 401(k) Plans Stress less by setting up a Safe Harbor 401(k). You can bypass some of the tests and focus on helping your employees save for their financial futures. “Your 401(k) plan failed.” Those words can strike fear in the hearts of even the most seasoned business owners. However, there’s a way to avoid the stress of your plan’s annual nondiscrimination testing. By setting up a safe harbor 401(k), you can bypass some of the tests, such as the ADP and ACP tests, and focus on helping your employees save for their financial futures. But is a safe harbor 401(k) right for your company? Read on for answers to frequently asked questions about safe harbor 401(k) plans. What is nondiscrimination testing? Before we explore safe harbor plans, let’s talk about nondiscrimination tests. Mandated by ERISA, these annual tests help ensure that 401(k) plans benefit all employees—not just business owners or highly compensated employees (HCEs). Because the government provides significant tax benefits through 401(k) plans, it wants to ensure that these perks don’t disproportionately favor high earners. The three main nondiscrimination tests are: Actual deferral percentage (ADP) test—Compares the average salary deferrals of HCEs to those of non-highly compensated employees (NHCEs). Actual contribution percentage (ADC) test—Compares the average employer contributions received by HCEs and NHCEs. Top-heavy test—Evaluates whether a plan is top-heavy, that is, if the total value of the plan accounts of “key employees” is more than 60% of the value of all plan assets. (IRS defines a key employee as an officer making more than $185,000, an owner of more than 5% of the business, or an owner of more than 1% of the business who made more than $150,000 during the plan year.] Why is it hard for 401(k) plans to pass nondiscrimination testing? It’s actually easier for large companies to pass the tests because they have many employees at varying income levels contributing to the plan. However, small and mid-size businesses may struggle to pass if they have a relatively high number of HCEs. If HCEs contribute a lot to the plan, but NHCEs don’t, there’s a chance that the 401(k) plan will not pass nondiscrimination testing. So, you may be wondering: “What happens if my plan fails?” Well, you’ll need to fix the imbalance by returning 401(k) plan contributions to your HCEs or by increasing contributions to your NHCEs. If you have to refund contributions, affected employees may fall behind on their retirement savings—and that money may be subject to state and federal taxes! If you don’t correct the issue in a timely manner, there could also be a 10% penalty fee and other serious ramifications. If you offer employees a safe harbor 401(k) plan, you can avoid these time-consuming, headache-inducing compliance tests. What is a safe harbor 401(k) plan? So, let’s back up for a minute. What exactly is a safe harbor 401(k) plan? Put simply, it’s a defined contribution retirement plan that’s exempt from nondiscrimination testing. It’s like a typical 401(k) plan except it requires you to contribute to the plan on your employees’ behalf, sometimes as an incentive for them to save in the plan. This mandatory employer contribution must vest immediately—rather than on a graded or cliff vesting schedule. This means your employees can take these contributions with them when they leave, no matter how long they’ve worked for the company. To fulfill safe harbor requirements, you can elect one of the following general contribution formulas: Basic safe harbor match—Employer matches 100% of employee contributions, up to 3% of their compensation, plus 50% of the next 2% of their compensation. Enhanced safe harbor match—Employer matches 100% of employee contributions, up to 4% of their compensation. Non-elective contribution—Employer contributes 3% of each employee’s compensation, regardless of whether they make their own contributions. These are only the minimum contributions. You can always increase non-elective or matching contributions to help your employees on the road to retirement. What are the benefits of a safe harbor 401(k) plan? At the end of the day, you want your employees to achieve the retirement they envision—and a safe harbor 401(k) plan can help them pursue it (while saving you time and effort). Consider these top five reasons to elect a safe harbor 401(k) plan: Attract and retain top talent—Offering your employees a matching or non-elective contribution is a powerful recruitment tool. In fact, a Betterment for Business study found that nearly half of respondents said a company match was a factor in whether or not they accepted a new job. Plus, an employer contribution is a great way to reward your current employees (and incentivize them to save for their future). Improve financial wellness—Studies show that financial stress impacts employees’ ability to focus on work. By helping your employees save for retirement, you help ease that burden and potentially improve your company’s productivity and profitability. Save time and stress—Administering your 401(k) plan takes time—and it can become even more time-consuming and stressful if you’re worried that your plan may not pass nondiscrimination testing. Skip the tests altogether by electing a safe harbor 401(k). Reward your top earners—With a safe harbor 401(k) plan, you can ensure that you and your HCEs will be able to max out your retirement contributions (without the fear that contributions will be returned if the plan fails nondiscrimination testing). Reduce your taxable income—Like any employer contribution, safe harbor contributions are tax deductible! Plus, you can receive valuable tax credits to help offset the costs of your 401(k) plan. An ideal solution for small businesses If you’ve failed nondiscrimination testing in the past—or are concerned that your lower earning employees won’t participate in a 401(k) plan—a safe harbor plan may be the best solution for your small business. Get a safe harbor 401(k) plan that works for you and your employees. Start now. What are the key cost considerations of offering a safe harbor 401(k) plan? The main consideration is that safe harbor contributions could increase your overall payroll by 3% or more depending upon your participation rates and contribution formula. Therefore, it’s important to think about whether your company has the financial capacity to make employer contributions on an annual basis. The good news is that 401(k) plans—including those with safe harbor provisions—are more affordable than they have been in the past. In fact, providers like Betterment now offer comprehensive plan solutions at low costs. Learn more now. How do I set up a safe harbor 401(k) plan? If you’re thinking about setting up a safe harbor plan or adding a safe harbor match to your existing plan, here are a few safe harbor 401(k) rules you need to know: Starting a new plan—For calendar year plans, October 1 is the final deadline for starting a new safe harbor 401(k) plan. But don’t cut it too close—you’re required to notify your employees 30 days before the plan starts. So, if you’re mulling over a safe harbor plan, be sure to talk to your plan provider well in advance. Adding a safe harbor match to an existing plan—If you want to add a safe harbor match provision to your current plan, you can include a plan amendment that goes into effect January 1. However, employees are required to receive a notice at least 30 days prior. Adding a safe harbor nonelective contribution to an existing plan—Thanks to the SECURE Act, plans that want to become a nonelective safe harbor plan have newfound flexibility. An existing plan can implement a 3% nonelective safe harbor provision for the current plan year if amended 30 days before the close of the plan year. Plans that decide to implement a nonelective safe harbor contribution of 4% or more have until the end of the following year in which the plan will become a safe harbor. Importantly, the SECURE Act eliminated the usual employee notice requirement for nonelective safe harbor plans. Communicating with employees—Every year, eligible employees need to be notified about their rights and obligations under your safe harbor plan (except for those with nonelective contributions, as noted in the previous bullet). Notice must be given at least 30 days, but no more than 90 days, before the beginning of the plan year. Want to learn more about notices? Visit the IRS website.A plan provider like Betterment will be able to assist you with everything you need to create the safe harbor 401(k) plan that’s right for your company. How do I select a safe harbor 401(k) plan provider? When it comes to choosing the right provider, it’s all about asking the right questions. Here’s how Betterment would answer them: Do you have experience setting up safe harbor 401(k) plans? Our team has significant experience working with safe harbor 401(k) plans. We help you understand each step of the onboarding process so you can start your plan quickly and easily. Plus, we have the expertise you need to handle every detail—from safe harbor 401(k) eligibility rules to investment options. How much does your service cost? Our fees are a fraction of the cost of most providers. Plus, we’re always fully transparent about fees so there are no surprises for you or your employees. How easy will it be for me to administer our plan on an ongoing basis? Our intuitive platform works to reduce your administrative burden. That means you’ll stay informed of what you need to do and when you need to do it—simplifying plan administration. Do you offer financial wellness support for employees? Our high-tech solution enables us to give employees holistic, personalized advice on everything from contribution rates to investments. Plus, we can link employees’ outside investments, savings accounts, IRAs, and spousal/partner assets, so they can get a big picture view of their long- and short-term financial goals. What is the deadline to adopt a safe harbor 401(k) plan for the 2021 plan year? If you are looking to implement a safe harbor plan for the 2021 plan year, it must be live by October 1, 2021. Sign up with Betterment by August 2, 2021 to start reaping the benefits of a safe harbor plan this plan year! Betterment is not a tax advisor. Please consult a qualified tax professional. -
What to Consider When Choosing a 401(k) Plan Recordkeeper
What to Consider When Choosing a 401(k) Plan Recordkeeper Selecting the right recordkeeper is important to the success of your 401(k) plan. A service provider who understands 401(k) plan administrative requirements and operational compliance can save you time, worry, and money. When you combine quality service with thoughtful plan design, appropriate investment options, and effective employee communications, you can drive strong savings behavior and increase the chances for a financially secure retirement for you and your employees. Prudently selecting a provider to help administer your plan and safeguard your employees’ retirement savings is also part of your fiduciary responsibility as the plan sponsor. Under ERISA, every plan must have at least one “named fiduciary.” The employer is typically the named fiduciary with overall responsibility for the plan. The plan must also designate an ERISA 3(16) plan administrator. This fiduciary has discretion over how the plan is operated and is often responsible for hiring service providers to help administer the plan and ensure that plan notices and disclosures are properly delivered. Most plan documents also name the employer as the ERISA plan administrator. As a fiduciary, you must adhere to high fiduciary standards in carrying out your responsibilities. This includes acting in the best interests of your participants and making sure only reasonable and necessary fees are paid from plan assets. Fortunately, there are skilled recordkeepers and other service providers to help you administer your 401(k) plan and meet your fiduciary responsibilities. 401(k) Plan Services and Who Provides Them So how do you find the 401(k) plan recordkeeper that’s right for you? One of the first steps is to understand what type of services you need and who provides them. A successful 401(k) plan typically requires four types of services: Plan recordkeeping and administrative support Participant services (account access and education) Operational compliance support (plan documents and nondiscrimination testing) Investment selection and monitoring Traditionally, different types of providers offered different types of services for 401(k) plans. Here are general definitions of 401(k) plan service providers: Recordkeeper – A recordkeeper is the bookkeeper for the day-to-day activities of the plan. This includes tracking participant activity such as deferral elections and investment allocations. A recordkeeper also tracks employer contributions and investment gains and losses. Most recordkeepers provide access to a platform of investments that can be selected by the plan fiduciary and made available to plan participants. Providing an easy-to-use and engaging website for participants and employers to access information and transact plan business is a critical element of recordkeeping services. A recordkeeper generally does not assume fiduciary responsibility for the plan but takes direction from the employer sponsoring the plan. Third Party Administrator (TPA) – A TPA provides compliance support to the employer and helps ensure the plan operates in accordance with the rules. This can include drafting and amending plan documents, conducting nondiscrimination testing, and filing an annual Form 5500 on behalf of the plan. In some cases, the role of the TPA and the recordkeeper may be filled by the same entity. Some TPAs also offer investment support services and may derive a portion of their revenue from the sale of investments. Most TPAs perform their administrative services at the direction of the employer and are not considered fiduciaries. However, some TPAs take on the role of the ERISA 3(16) plan fiduciary relieving employers from the fiduciary responsibility for certain plan operations. Trustee – 401(k) plan assets must be held in a trust for the benefit of each participant (unless the assets consist only of insurance contracts). A trustee is typically named in the plan document or a trust agreement. Some employers choose to serve as the plan’s trustee, referred to as a self-trusteed plan. In other cases, a separate entity such as a trust company will be appointed to assume legal title to the plan assets and to provide annual trust or account statements. All trustees are considered to be plan fiduciaries and are subject to strict standards when handling the assets of 401(k) plan participants. Financial Advisor – A financial advisor typically serves as an employer’s investment expert. The financial advisor may also help employers identify their objectives for sponsoring a retirement plan and then help determine the types of services and service model that will meet those objectives. Financial advisors are also typically involved in employee enrollment meetings and providing additional employee education. Those who advise on investments may take on a fiduciary role, serving as either an ERISA 3(21) investment advisor (makes recommendations) or an ERISA 3(38) investment manager (has discretion to select investments for the plan). To Bundle or Unbundle? In today’s market, one entity may fill more than one service provider role for a retirement plan. There are multiple combinations of services possible, depending on the provider and their affiliates. For example, a recordkeeper may also serve as the TPA, or an investment provider may provide recordkeeping services. Some service providers coordinate their services to present a comprehensive solution, known as a bundled service model. For example, a single entity may design a product that includes all facets of retirement plan services – fiduciary investment support, plan documents, recordkeeping, and compliance support. Or a service provider may choose to bundle just a few services such as the recordkeeping and TPA functions. Other providers specialize in just one area of 401(k) plan servicing and don’t affiliate with any other providers. With these types of unbundled providers, the employer is responsible for selecting and engaging independently with each provider and monitoring their performance. A Prudent Process Looking for a 401(k) plan recordkeeper or considering whether you want to change recordkeepers is a fiduciary function, so it’s important to follow a careful process and document your decisions. Consider whether you can manage a group of independent service providers or would benefit from a bundled service model. You may want to start by reviewing a provider’s service agreement to identify the specific services that will be provided, including whether the provider is assuming a fiduciary role as part of those services. Compare multiple providers’ services and fees, so you understand what fees are reasonable in the industry for your plan size and the types of services and features that are most important to you and your participants. Here is a list of elements you may want to consider when evaluating service providers: Types of Services Offered Scope of recordkeeping and administration support Compliance support such as plan documents and nondiscrimination testing Investment advise or support – at the plan level and the participant level Fiduciary services (ERISA 3(16) plan administration, ERISA 3(21) investment advice, or ERISA 3(38) investment management) Employee education programs or employee communication support Online account access and phone/email support services Fees Costs for plan services and investments Transparency of fees Payment structure (e.g., can fees be paid by the business or debited from participant accounts? Are fees paid through a revenue sharing arrangement?) Qualifications of Provider The depth of technical expertise within the organization Experience with plans having similar characteristics Service levels promised, such as turnaround times for common transactions The investment approach or philosophy The sophistication of technology and online tools Referrals or recommendations from other clients Ready for a Better 401(k)? Betterment for Business offers a bundled approach to servicing 401(k) plans, so you don’t need to navigate through multiple providers’ service models and fee structures or worry about gaps in services. We specialize in servicing small businesses for low cost to save you money. And our digital platform makes it easy for you to set up and maintain a 401(k) plan and for your employees to access their account balances and investments. We’re committed to being here for you every step of the way with expert investment and administrative support, including fiduciary 3(16) and 3(38) services. -
What is Form 5330?
What is Form 5330? If you’ve been told you need to file a Form 5330, you’re probably wondering what it is and why you need to file it. IRS Form 5330 is used when paying excise taxes related to employee benefit plans, including 401(k) plans, even though the error that caused the excise tax has already been corrected. While Betterment can help answer questions, typically your accountant or attorney will help you prepare this filing. When would a 401(k) plan incur excise taxes? Although no plan sponsor wants or expects to incur excise taxes, sometimes a 401(k) plan may trigger an excise tax due to administrative oversight, most often when employee deferrals are deposited late. Although the form covers nearly two dozen situations, some of the most common situations are outlined below. Note that the amount of the excise tax and the filing deadline varies depending on the reason for the excise tax. Note that you must file one Form 5330 to report all excise taxes with the same filing deadline. Reason for Excise Tax Description Amount of Excise Tax Filing Deadline Late deposits of employee deferrals (late payroll) For small businesses, deposits are considered late if they are made more than 7 business days from the date deferrals were withheld from payroll. Large plans must deposit contributions as soon as administratively feasible but no later than 15 business days of the month after the contribution was withheld. However, if the plan has established a precedent for depositing contributions earlier, then that precedent will define what is considered late. 15% of lost earnings Last day of the 7th month after plan year end Failed ADP/ACP test refunds issued after deadline Refunds issued more than 2 ½ months after the close of the plan year are considered late. 10% of the refund excluding investment gains 15 months after the close of the plan year Contributions exceeding the annual tax deduction limit An employer’s deductions for contributions to a 401(k) plan cannot be more than 25% of the compensation paid during the year to eligible employees participating in the plan. 10% of the excess contribution Last day of the 7th month after the plan year-end Penalties for late filing and late payment Failure to file Form 5330 on time results in a 5% penalty each month, up to a maximum of 25% of the unpaid tax. Failure to pay excise taxes on time may result in a penalty of ½ of 1% of the unpaid tax for each month, up to a maximum of 25% of the unpaid tax. Penalties will not be imposed if you can show that the failure to pay on time was due to reasonable cause. Interest and penalties for late filing and late payment will be billed separately after the return is filed. Deadline extension The deadline to file Form 5330 may be extended for up to six months by filling a Form 5558 on or before the date the 5330 is due. The extension applies only to Form 5330, not to the payment of the excise tax, which must be paid on or before the original deadline. Links to forms, instructions and useful information IRS forms are periodically updated, so be sure to download the latest form and other relevant information from the IRS website. IRS Form 5330 Corner from IRS website, with links to latest Form 5330 and instructions. About Form 5558 (Application for Extension of Time to File Certain Employee Plan Returns) from IRS website, including link to latest form. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. -
401(k) Glossary of Terms
401(k) Glossary of Terms Whether you're offering a 401(k) for the first time or need a refresh on important terms, these definitions can help you make sense of industry jargon. 3(16) fiduciary: A fiduciary partner hired by an employer to handle a plan’s day-to-day administrative responsibilities and ensure that the plan remains in compliance with Department of Labor regulations. 3(21) fiduciary: An investment advisor who acts as co-fiduciary to review and make recommendations regarding a plan’s investment lineup. This fiduciary provides guidance but does not have the authority to make investment decisions. 3(38) fiduciary: A codified retirement plan fiduciary that’s responsible for choosing, managing, and overseeing the plan’s investment options. 401(k) administration costs: The expenses involved with the various aspects of running a 401(k) plan. Plan administration includes managing eligibility and enrollment, coordinating contributions, processing distributions and loans, preparing and delivering legally required notices and forms, and more. 401(k) committee charter: A document that describes the 401(k) committee’s responsibilities and authority. 401(k) compensation limit: The maximum amount of compensation that’s eligible to draw on for plan contributions, as determined by the IRS. In 2020, this limit is $285,000. Keep in mind that contributions are also limited by the 401(k) contribution limit, which is $19,500 in 2020 for those under age 50. 401(k) contribution limits: The maximum amount that a participant may contribute to an employer-sponsored 401(k) plan, as determined by the IRS. For 2020, the limits are $19,500 for individuals under age 50, and $26,000 for individuals age 50 and older (including $6,500 in catch-up contributions). 401(k) force-out rule: Refers to a plan sponsor’s option to remove a former employee’s assets from the retirement plan. The sponsor has the option to “force out” these assets (into an IRA in the former employee’s name) if the assets are less than $5,000. 401(k) plan: An employer-sponsored retirement savings plan that allows participants to save money on a tax-advantaged basis. 401(k) plan fees: The various fees associated with a plan. These can include fees for investment management, plan administration, fiduciary services, and consulting fees. While some fees are applied at the plan level — that is, deducted from plan assets — others are charged directly to participant accounts. 401(k) plan fee benchmarking: The process of comparing a plan’s fees to those of other plans in similar industries with roughly equal assets and participation rates. This practice can help to determine if a plan’s fees are reasonable. 401(k) set-up costs: The expenses involved in establishing a 401(k) plan. These costs cover plan documents, recordkeeping, investment management, participant communication, and other essential aspects of the plan. 401(k) withdrawal: A distribution from a plan account. Because a 401(k) plan is designed to provide income during retirement, a participant generally may not make a withdrawal until age 59 ½ unless he or she terminates or retires; becomes disabled; or qualifies for a hardship withdrawal. Any other withdrawals before age 59 ½ are subject to a 10% penalty as well as regular income tax. 404(a)(5) fee disclosure: A notice issued by a plan sponsor that details information about investment fees. This notice, which is required of all plan sponsors by the Department of Labor, covers initial disclosure for new participants, new fees, and fee changes. 404(c) compliance: Refers to a participant’s (or beneficiary’s) right to choose the specific investments for 401(k) plan assets. Because the participant controls investment decisions, the plan fiduciary is not liable for investment losses. 408(b)(2) fee disclosure: A notice issued by a plan service provider that details the fees charged by the provider (and its affiliates or subcontractors) and reports any possible conflicts of interest. The Department of Labor requires all plan fiduciaries to issue this disclosure. Actual contribution percentage (ACP) test: A required compliance test that compares company matching contributions among highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Actual deferral percentage (ADP) test: A required compliance test that compares employee deferrals among highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Annual fee disclosure: A notice issued by a plan sponsor that details the plan’s fees and investments. This disclosure includes plan and individual fees that may be deducted from participant accounts, as well as information about the plan’s investments (performance, expenses, fees, and any applicable trade restrictions). Automated Clearing House (ACH): A banking network used to transfer funds between banks quickly and cost-efficiently. Automatic enrollment (ACA): An option that allows employers to automatically deduct elective deferrals into the plan from an employee’s wages unless the employee actively elects not to contribute or to contribute a different amount. Beneficiary: The person or persons who a participant chooses to receive the assets in a plan account if he or she dies. If the participant is married, the spouse is automatically the beneficiary unless the participant designates a different beneficiary (and signs a written waiver). If the participant is not married, the account will be paid to his or her estate if no beneficiary is on file. Blackout notice: An advance notice of an upcoming blackout period. ERISA rules require plan sponsors to notify participants of a blackout period at least 30 days in advance. Blackout period: A temporary period (three or more business days) during which a 401(k) plan is suspended, usually to accommodate a change in plan administrators. During this period, participants may not change investment options, make contributions or withdrawals, or request loans. Catch-up contributions: Contributions beyond the ordinary contribution limit, which are permitted to help people age 50 and older save more as they approach retirement. In 2020, contribution limits (set by the IRS) are $19,500 on ordinary contributions and $6,500 on catch-up contributions, for a combined limit of $26,000. Compensation: The amount of pay a participant receives from an employer. For purposes of 401(k) contribution calculations, only compensation, which is reported on a W-2 is considered to be eligible. Constructive receipt: A payroll term that refers to the impending receipt of a paycheck. The paycheck has not yet been fully cleared for deposit in the employee’s bank account, but the employee has access to the funds. Deferrals: Another term for contributions made to a 401(k) account. Defined contribution plan: A tax-deferred retirement plan in which an employee or employer (or both) invest a fixed amount or percentage (of pay) in an account in the employee’s name. Participation in this type of plan is voluntary for the employee. A 401(k) plan is one type of tax-deferred defined contribution plan. Department of Labor (DOL): The federal government department that oversees employer-sponsored retirement plans as well as work-related issues including wages, hours worked, workplace safety, and unemployment and reemployment services. Distributions: A blanket term for any withdrawal from a 401(k) account. A distribution can include a required minimum distribution (RMD), a loan, a hardship withdrawal, a residential loan, or a qualified domestic relations order (QDRO). Docusign: A third-party platform used for exchanging signatures on documents, especially during plan onboarding. EIN: An employer’s identification number, which is listed on Form 5500. Eligible automatic enrollment arrangement (EACA): An automatic enrollment (ACA) plan that applies a default and uniform deferral percentage to all employees who do not opt out of the plan or provide any specific instructions about deferrals to the plan. Under this arrangement, the employer is required to provide employees with adequate notice about the plan and their rights regarding contributions and withdrawals. ERISA: Refers to the Employee Retirement Income Security Act of 1974, a federal law that requires individuals and entities that manage a retirement plan (fiduciaries) to follow strict standards of conduct. ERISA rules are designed to protect retirement plan participants and secure their access to benefits in the plan. Excess contributions: The amount of contributions to a plan that exceed the IRS contribution limit. Excess contributions made in any year (and their earnings) may be withdrawn without penalty by the tax filing deadline for that year, and the participant is then required to pay regular taxes on the amount withdrawn. Any excess contributions not withdrawn by the tax deadline are subject to a 6% excise tax every year they remain in the account. Exchange-traded fund (ETF): Passively managed index funds that feature low costs and high liquidity. ETFs make it easy to manage portfolios efficiently and effectively. All of Betterment’s investment options are ETFs. Fee disclosure: Information about the various fees related to a 401(k) plan, including plan administration, fiduciary services, and investment management. Fee disclosure deadline: The date by which a plan sponsor must provide plan and investment-related fee disclosure information to participants. For calendar-year plans, the deadline is August 31. Fidelity bond: Also known as a fiduciary bond, this bond protects the plan from losses due to fraud or dishonesty. Every fiduciary who handles 401(k) plan funds is required to hold a fidelity bond. Fiduciary: An individual or entity that manages a retirement plan and is required to always act in the best interests of employees who save in the plan. In exchange for helping employees build retirement savings, employers and employees receive special tax benefits, as outlined in the Internal Revenue Code. When a company adopts a 401(k) plan for employees, it becomes an ERISA fiduciary and takes on two sets of fiduciary responsibilities: “Named fiduciary” with overall responsibility for the plan, including selecting and monitoring plan investments “Plan administrator” with fiduciary authority and discretion over how the plan is operated Most companies hire one or more outside experts (such as an investment advisor, investment manager, or third-party administrator) to help manage their fiduciary responsibilities. Form 5500: An informational document that a plan sponsor must prepare to disclose the identity of the plan sponsor (including EIN and plan number), characteristics of the plan (including auto-enrollment, matching contributions, profit-sharing, and other information), the numbers of eligible and active employees, plan assets, and fees. The plan sponsor must submit this form annually to the IRS and the Department of Labor, and must provide a summary to plan participants. Smaller plans (less than 100 employees) may instead file Form 5500-SF. Hardship withdrawal: A withdrawal before age 59 ½ intended to address a severe and immediate need ( as defined by the IRS). To qualify for a hardship withdrawal, a participant must provide the employer with documentation (such as a medical bill, a rent invoice, funeral expenses) that shows the purpose and amount needed. If the hardship withdrawal is authorized, it must be limited to the amount needed (adjusted for taxes and penalties), may still be subject to early withdrawal penalties, is not eligible for rollover, and may not be repaid to the plan. Highly compensated employee (HCE): An employee who earned at least $125,000 in compensation from the plan sponsor during the previous year (if 2019), or at least $130,000 if the previous year is 2020, or owned more than 5% interest in the plan sponsor’s business at any time during the current or previous year (regardless of compensation). Inception to date (ITD): Refers to contribution amounts since the inception of a participant’s account. Internal Revenue Service (IRS): The U.S. federal agency that’s responsible for the collection of taxes and enforcement of tax laws. Most of the work of the IRS involves income taxes, both corporate and individual. Investment advice (ERISA ruling): The Department of Labor’s final ruling (revised in 2016) on what constitutes investment advice and what activities define the role of a fiduciary. Investment policy statement (IPS): A plan’s unique governing document, which details the characteristics of the plan and assists the plan sponsor in complying with ERISA requirements. The IPS should be written carefully, reviewed regularly, updated as needed, and adhered to closely. Key employee: An employee classification used in top-heavy testing. This is an employee who meets one of the following criteria: Ownership stake greater than 5% Ownership stake greater than 1% and annual compensation greater than $150,000 Officer with annual compensation greater than $185,000 (for 2020) Non-discrimination testing: Tests required by the IRS to ensure that a plan does not favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). There are three tests: Actual deferral percentage (ADP) test—Compares the average salary deferral of HCEs to that of NHCEs. Actual contribution percentage (ACP) test—Compares the average employer contributions received by HCEs and NHCEs. (This test is only required if plan makes employer contributions.) Top-heavy determination—Evaluates whether a plan is top-heavy; that is if the total value of the plan accounts of “key employees” is more than 60% of the value of all plan assets. Non-elective contribution: An employer contribution to an employee’s plan account that’s made regardless of whether the employee makes a contribution. This type of contribution is not deducted from the employee’s paycheck. Non-highly compensated employee (NHCE): An employee who does not meet any of the criteria of a highly compensated employee (HCE). Plan sponsor: An organization that establishes and offers a 401(k) plan for its employees or members. Qualified default investment alternative (QDIA): The default investment for plan participants who don’t make an active investment selection. All 401(k) plans are required to have a QDIA. For Betterment’s 401(k), the QDIA is one of 101 portfolios (based on age) that make up the Core Portfolio Strategy. Qualified domestic relations order (QDRO): A document that recognizes a spouse’s, former spouse’s, child’s, or dependent’s right to receive benefits from a participant’s retirement plan. Typically approved by a court judge, this document states how an account must be split or reassigned. Plan administrator: An individual or company responsible for the day-to-day responsibilities of 401(k) plan administration. Among the responsibilities of a plan administrator are compliance testing, maintenance of the plan document, and preparation of the Form 5500. Many of these responsibilities may be handled by the plan provider or a third-party administrator (TPA). Plan document: A document that describes a plan’s features and procedures. Specifically, this document identifies the type of plan, how it operates, and how it addresses the company’s unique needs and goals. Professional employer organization (PEO): A firm that provides small to medium-sized businesses with benefits-related and compliance-related services. Profit sharing: A type of defined contribution plan in which a plan sponsor contributes a portion of the company’s quarterly or annual profit to employee retirement accounts. This type of plan is often combined with an employer-sponsored retirement plan. Promissory note: A legal document that lays out the terms of a 401(k) loan or other financial obligation. Qualified non-elective contribution (QNEC): A contribution that a plan is required to make if it’s found to be top-heavy. Required minimum distribution (RMD): Refers to the requirement that an owner of a tax-deferred account begin making plan withdrawals each year starting at age 72. The first withdrawal must be made by April 1 of the year after the participant reaches age 72, and all subsequent annual withdrawals must be made by December 31. Rollover: A retirement account balance that is transferred directly from a previous employer’s qualified plan to the participant’s current plan. Consolidating accounts in this way makes it easier for a participant to manage and track retirement investments, and may also reduce retirement account fees. Roth 401(k) contributions: After-tax plan contributions that do not reduce taxable income. Contributions and their earnings are not taxed upon withdrawal as long as the participant is at least age 59½ and has owned the Roth 401(k) account for at least five years. For 2020, the limits on plan contributions (Traditional, Roth, or a combination of both) are $19,500 for individuals under age 50, and $26,000 for individuals age 50 and older (including $6,500 in catch-up contributions). Roth IRA contributions: After-tax IRA contributions that do not reduce current taxable income. Contributions and their earnings are not taxed upon withdrawal. In 2020, the Roth IRA contribution limit is $6,000 for those under age 50 and $7,000 for ages 50 or older. A single tax filer may make a full contribution as long as the modified adjusted gross income is less than $124,000. Roth vs. pre-tax contributions: Pre-tax contributions reduce a participant’s current income, with taxes due when funds are withdrawn (typically in retirement). Alternatively, Roth contributions are deposited into the plan after taxes are deducted, so withdrawals are tax-free. Safe Harbor: One of three plan designs that provides annual testing exemptions. In exchange, employer contributions on behalf of all employees are required. Saver’s credit: A credit designed to help low- and moderate-income taxpayers further reduce their taxes by saving for retirement. The amount of this credit — 10%, 20%, or 50% of contributions, based on filing status and adjusted gross income — directly reduces the amount of tax owed. Stock option: The opportunity for an employee to purchase shares of an employer’s stock at a specific (often discounted) price for a limited time period. Some companies may offer a stock option as an alternative or a complement to a 401(k) plan. Summary Annual Report (SAR): A summary version of Form 5500, which a plan sponsor is required to provide to participants every year within two months after filing Form 5500. Summary Plan Description (SPD): A comprehensive document that describes in detail how a 401(k) plan works and the benefits it provides. Employers are required to provide an SPD to employees free of charge. Third-party administrator (TPA): An individual or company that may be hired by a 401(k) plan sponsor to help run many day-to-day aspects of a retirement plan. Among the responsibilities of a TPA are compliance testing, generation and maintenance of the plan document, and preparation of Form 5500. Top-heavy test: An annual compliance test that examines the plan assets of key employees relative to total plan assets. If key employee assets make up more than 60% of total assets, then the plan must make a top-heavy minimum contribution, usually in the form of a nonelective contribution. Traditional contributions: Pre-tax plan contributions that reduce taxable income. These contributions and their earnings are taxable upon withdrawal, which is typically during retirement. For 2020, the limits on plan contributions (Traditional, Roth, or a combination of both) are $19,500 for individuals under age 50, and $26,000 for individuals age 50 and older (including $6,500 in catch-up contributions). Vesting: Another word for ownership. Participants are always fully vested in the contributions they make. Employer contributions, however, may be subject to a vesting schedule in which participant ownership builds gradually over several years. -
What is the Right Default Savings Rate?
What is the Right Default Savings Rate? Don’t let the 3% typical default rate anchor weigh you down. Place your anchor to windward at 6% or higher for safety and protection. 401(k) plan sponsors who implement auto-enrollment have a critical decision to make: at what savings rate should participants save? Because participants are not actively signing up for the plan, they are not making their own decision. Instead, the company will do it for them, selecting the right level of savings for all employees. This is a big responsibility for companies and getting it right will make the difference between a sufficiently saved population and one that will remain in the workforce beyond traditional retirement age. Understanding the 3% anchor Anchors can either hold someone steady or drag them down. They set an expectation and become a shortcut in people’s minds making it harder for them to process information that may point to a different, possibly more appropriate, fact. In the 401(k), 3% has been the traditional annual default savings amount. It’s clear that participants need to save closer to 10% - 20% each year for savings sufficiency. But asking decision makers to approve a change from a 3% savings rate to a 20% savings rate is a total non-starter. They’d be bracing for an employee rebellion. It’s clear to get to the savings level participants need, we must break the decision down into smaller steps and create a path for the participant to gradually achieve the greater savings level. How to not use 3% Let’s say, like many others in your industry, you have a 3% default savings rate. You know it’s not enough for participants and you hear about other plans that have increased the default savings rate to 6%. Still, you need to make a decision, but you worry about two things: 1) can you get the administrative decision makers to approve doubling the default savings rate? 2) will participants be upset that you are “taking” even more money from their paycheck? Reframing the default For decision makers and participants alike, the tactic is to reframe the default. In some situations, this can be done in a single presentation to decision makers and communication to participants. In other cases, in a particularly cynical environment, or one where there’s some financial hardship, it may take a series of discussions and communications to prepare the decision makers and participants alike. With decision makers: Lay the groundwork. Start wondering aloud if participants in your plan are saving enough. Share research that participants will need to save 10-20% of their annual income to have sufficient savings at retirement. Is 3% the right level for a default rate? Get the data. Start researching the savings levels of participants in your plan. What percentage of the population is saving less than 3%? How many are saving at exactly 3%? How many are saving more than 3%? Project the future. How it is in the participants’ best interest to increase their savings rate now to impact their future financial health? What power does compounding have to grow a nest egg? How does it improve their chances to be able to retire when they wish to? Drive employee engagement. Benefits are a tool for the company to drive employee engagement. Most people know they should be saving for retirement and be saving more. Research shows that participants who focus on retirement, recognize their high-quality plan, and appreciate their employer for providing it, have higher employee engagement. Determine the impact. Understand the impact to your company of your participants not saving enough. Combine the “under-saved” population with the “not saving at all” population. What percentage of your population could be unprepared to retire? If people start working longer, when does this begin to affect your business in terms of lost productivity and additional health care and disability costs? These steps may not all be necessary, but taken over time, one or more of them will likely get you the vote you’re looking for to increase the default savings rate. With participants: Communicate wisely. No one likes to hear that they’ll have to double their savings rate. So, rather than saying: “We’re doubling your default rate, now you’re saving 6%,” say: “Research shows you should save 10%-20% of your income for retirement. Right now you’re saving 3%. We’re going to help you start to save at 6%. It’s a small step in the right direction.” Activate the match. A great way to incent savings is through a company match. Let’s say you have a match of 3%: Remind those saving below the match threshold that this increase will automatically make them eligible to receive a more match money. For participants who were saving at 1%, they’ll get an additional 2% from the company. Relate the savings update to the match. You can either stretch the match if it was a 3% match before ($1 for $1 up to 3%) or convert it to your 6% goal ($0.50 to $0.50 on the first 6%). By aligning the default savings rate with the match you’ve created a new incentive to save at 6%. Reassure. Remind participants that if it is truly too hard for them to save right now, they can opt out. Maybe they can save more later. Set up a plan design cadence so that you occasionally reach back out to try to boost savings back up to 6%. In these examples, 6% is the new 3%. Is that the right level for a default savings rate? Probably not. But taking a step to increase the default savings rate even a little bit is important work. According to one survey, most large plans have now moved to a 6% default rate. Combined with more savings through automated annual increases, for example, it’s an important first step to get people saving more. Don’t let the 3% anchor weigh you down. Place your anchor to windward at 6% or higher for safety and protection. Laraine McKinnon is the author of “Known: How to Create a Great 401(k)” (© 2020, LMC17, LLC) and serves as an Advisor to Betterment for Business. She is founder and CEO of LMC17, a strategic consulting firm that focuses on hard-to-solve problems in the human resources and talent arena. -
What Does It Mean to be a 401(k) Plan Sponsor?
What Does It Mean to be a 401(k) Plan Sponsor? If you’re new to the world of 401(k)s and wondering what it means to be a plan sponsor, we have you covered. We applaud you for considering a 401(k) plan. Not only can an effective plan make a difference in helping employees save for their future, but it can enhance your organization’s recruiting efforts. If you’re new to the world of 401(k)s and wondering what it means to be a plan sponsor, we have you covered. Betterment will partner with you every step of the way and is always available to answer your questions. Getting Your Plan Set Up Betterment will need to know more about your organization to prepare a plan document for your review and approval, outlining key plan provisions such as eligibility requirements, company matching provisions, enrollment type (automatic or voluntary) and vesting schedules. We will guide you through these decisions (much of it through our online Onboarding Hub) and share best practices so that your plan meets the needs of your organization and your employees. Since you are required to administer the plan in accordance with the plan document, it's important that you and those responsible for the plan’s operations are familiar with it. Periodic amendments prepared by Betterment will ensure the plan remains in compliance with changing regulatory requirements and evolving decisions by the company. Before any funds can flow into the plan, you are also required by law to purchase a fidelity bond that protects the plan against fraudulent or dishonest acts made by anyone at your organization that may help administer the plan. Understanding Your Fiduciary Responsibilities 401(k) plan sponsors have important fiduciary responsibilities and must adhere to specific standards of conduct as defined by Employee Retirement Income Security Act (ERISA): Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them Carrying out their duties prudently Following the plan documents Diversifying plan investments Paying only reasonable plan expenses Betterment acts as your 3(16) fiduciary for certain administrative functions and acts as a 3(38) investment manager, which provides you with a higher level of investment fiduciary protection. However, you still have an obligation to monitor us and anyone to whom you delegate your fiduciary obligations; you can never fully eliminate these. Ongoing and Annual Responsibilities Betterment will handle much of your plan administration, but as plan sponsor, there are certain responsibilities that fall to you, including: Ensuring eligible employees are appropriately identified (if payroll is integrated, Betterment enforces your plan’s eligibility requirements) Making sure that employee decisions are accurately captured and reflected in your payroll system Making sure that employee changes are reflected in the Betterment system Approving participant loans (if offered) distribution requests Reviewing results of compliance tests performed by Betterment (annually) Signing Form 5500 prepared by Betterment (annually) Staying Informed The 401(k) industry is constantly changing, and Betterment keeps its finger on the pulse of what’s going on. We regularly add relevant articles to our website and will keep you informed of any changes that may impact your plan. We look forward to working with you and are here to answer any questions you may have. -
Understanding your 401(k) Plan Document
Understanding your 401(k) Plan Document Betterment will draft your 401(k) plan document, but it’s important that you understand what it includes and that you follow it as written. What exactly is a Plan Document? A 401(k) plan is considered a qualified retirement plan by the Internal Revenue Service (IRS), and as such, must meet certain requirements to take advantage of significant tax benefits. Every 401(k) retirement plan is required to have a plan document that outlines how the plan is to be operated. The plan document should reflect your organization’s objectives in sponsoring the 401(k) plan, including information such as plan eligibility requirements, contribution formulas, vesting requirements, loan provisions, and distribution requirements. As regulations change or your organization changes plan features and/or rules, the plan document will need to be amended. Your provider will likely draft your plan’s document, but because of your fiduciary duty, it is important that you as plan sponsor review your plan document, understand it, and refer to it if questions arise. Whether you are a small business or a large corporation, failure to operate the plan in a manner consistent with the document as written can result in penalties from the IRS and/or the Department of Labor (DOL). Understanding Your Fiduciary Responsibilities Although a given 401(k) plan may have multiple (and multiple types of) fiduciaries based on specific plan functions, the plan document identifies the plan’s “Named Fiduciary” who holds the ultimate authority over the plan and is responsible for the plan’s operations, administration and investments. Typically the employer as plan sponsor is the Named Fiduciary. The employer is also the “plan administrator” with responsibility for overall plan governance. While certain fiduciary responsibilities may be delegated to third parties, fiduciary responsibility can never be fully eliminated or transferred. All fiduciaries are subject to the five cornerstone rules of ERISA (Employee Retirement Income Security Act) when managing the plan’s investments and making decisions regarding plan operations: Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them; Carrying out their duties prudently; Following the plan documents (unless inconsistent with ERISA); Diversifying plan investments; and Paying only reasonable plan expenses. One of the best ways to demonstrate that you have fulfilled your fiduciary responsibilities is to document your decision-making processes. Many plan sponsors establish a formal 401(k) plan committee to help ensure that decisions are appropriately discussed and documented. Which Type of 401(k) Plan is Best for Your Organization? The plan document will identify the basic plan type, which usually falls into one of two categories. Both types allow employees to make contributions via payroll deduction. Traditional 401(k) plans provide maximum flexibility with respect to employer contributions and associated vesting schedules (defining when those contributions become owned by the employee). However, these plans are subject to annual nondiscrimination testing to ensure that the plan benefits all employees—not just business owners or highly compensated employees (HCEs). Safe Harbor 401(k) plans are deemed to pass certain nondiscrimination tests but require employers to contribute to the plan on behalf of employees. This mandatory employer contribution must vest immediately—rather than on a graded or cliff vesting schedule. The 2019 SECURE Act relaxed certain safe harbor requirements. Profit-sharing 401(k) plans include an additional component that allows employers to make more significant contributions to their employee accounts. Besides helping to attract and retain talent, small businesses can find this feature especially helpful In highly profitable years, since it reduces taxable income. There is no one plan type that is better than another, but this flexibility allows you to determine which type makes the most sense for your organization. Eligibility Requirements to Meet Your Needs Although the IRS mandates that employees age 21 or older with at least 1 year of service are eligible to make employee deferrals, employers do have considerable flexibility in setting 401(k) plan eligibility: Age -- employers often choose to adopt a minimum age of 18 Service -- employers can establish requirements on elapsed time or hours Entry date -- employers may allow employees to participate in the plan immediately upon hiring but often require some waiting period. For example, employees may have to wait until the first of the month or quarter following their hire date. This flexibility allows employers to adopt eligibility requirements appropriate to their business needs. For instance, a company with high turnover or lots of seasonal workers may institute a waiting period to reduce the number of small balance accounts and the associated administrative costs. As a result of the SECURE Act, beginning in 2021, plans must provide access for part-time workers who haven’t met 1,000 hours in one year, but have worked for over 500 hours for an employer for at least three years. Automatic Enrollment may be the Way to Go Enrollment in a 401(k) plan can either be voluntary or automatic. As retirement savings has become ever more essential for workers, employers are increasingly choosing to adopt automatic enrollment, whereby a set percentage is automatically deferred from employee paychecks and contributed to the plan, unless an employee explicitly elects to “opt out” or not contribute. The benefit of automatic enrollment is that human inertia means most employees take no action and start saving for their future. In fact, according to research by The Pew Charitable Trusts, automatic enrollment 401(k) plans have participation rates greater than 90% compared to the roughly 50% participation rate for plans with voluntary enrollment. Employee Contribution Flexibility Provides Valuable Flexibility The plan document will specify the types of contributions (or “elective deferrals”) that eligible employees can make to the plan via payroll deduction. Typically these will be either pre-tax contributions or Roth (made with after-tax dollars) contributions. Allowing plan participants to decide when to pay the taxes on their contributions can provide meaningful flexibility and tax diversification benefits. Elective deferrals are often expressed as either a flat dollar amount or as a percentage of compensation. Employee contribution limits are determined each year by the IRS. The plan document must specify whether the plan will allow catch-up contributions for those age 50 and older. Able and/or Willing to Contribute to Employee Accounts? The plan document will also include provisions regarding employer contributions, which can be made on either a matching or non-matching basis. Matching contributions are often used to incentivize employees to participate in the plan. For example, an employer may match 50% of every $1 an employee contributes, up to a maximum of 6% of compensation. For traditional 401(k) plans, matching contributions can be discretionary so that the employer can determine not only how much to contribute in any given year but whether or not to contribute at all. As stated above, matching employer contributions are required for Safe Harbor 401(k) plans. The plan document may also permit the employer to make contributions other than matching contributions. These so-called “nonelective” contributions would be made on behalf of all employees who are considered plan participants, regardless of whether they are actively contributing. Vesting Schedules and Employee Retention Vesting simply means ownership. Employees own, or are fully vested, in their own contributions at all times. Employers with traditional 401(k) plans, however, often impose a vesting schedule on company contributions to encourage employee retention. Although there are a wide variety of approaches to vesting, one of the most common is to use a graded vesting schedule. For instance, an employee would vest in the employer contribution at a rate of 25% each year and be 100% vested after 4 years. Employer contributions as part of Safe Harbor 401(k) plans are vested immediately. Let Betterment help you create a 401(k) that works for you and your employees As a full-service provider, Betterment aims to make life easy for you. We will draft your plan document based on your preferences and our industry expertise of best practices. We will work to keep your plan in compliance at all times and can prepare amendments based on your changing needs. Sign up for a free demo to see the true impact of our 401(k) plan. -
Understanding 401(k) Fees
Understanding 401(k) Fees Come retirement time, the number of 401(k) plan fees charged can make a major difference in your employees’ account balances—and their futures. Did you know that the smallest 401(k) plans often pay the most in fees? According to a research study, most large plans with over $100 million in assets pay fees below 1%. However, small plans often pay between 1.5% and 2%—or even more! We believe that you don’t have to pay high fees to provide your employees with a top-notch 401(k) plan. In fact, Betterment offers comprehensive plan solutions for a fraction of the cost of most providers. Why do 401(k) fees matter? The difference between a 1% fee and a 2% fee may not sound like much, but in reality, higher 401(k) fees can take a major bite out of your participants’ retirement savings. Consider this example: Triplets Jane, Julie, and Janet each began investing in their employers’ 401(k) plan at the age of 25. Each had a starting salary of $50,000, increased by 3% annually, and contributed 6% of their pre-tax salary with no company matching contribution. Their investments returned 6% annually. The only difference is that their retirement accounts were charged annual 401(k) fees of 1%, 1.5%, and 2%, respectively. Forty years later, they’re all thinking about retiring and decide to compare their account balances. Here’s what they look like: Annual 401(k) fee Account balance at age 65 Jane 1% $577,697 Julie 1.5% $517,856 Janet 2% $465,894 As you can see, come retirement time, the amount of fees charged can make a major difference in your employees’ account balances—and their futures. Why should employers care about 401(k) fees? You care about your employees, so naturally, you want to help them build brighter futures. But beyond that, it’s your fiduciary duty as a plan sponsor to make sure you’re only paying reasonable 401(k) fees for services that are necessary for your plan. The Department of Labor (DOL) outlines rules that you must follow to fulfill this fiduciary responsibility, including “ensuring that the services provided to the plan are necessary and that the cost of those services is reasonable” and has published a guide to assist you in this process. Generally, any firm providing services of $1,000 or more to your 401(k) plan is required to provide a fee disclosure, which is the first step in understanding your plan’s fees and expenses. It’s important to note that the regulations do not require you to ensure your fees are the lowest available, but that they are reasonable given the level and quality of service and support you and your employees receive. Benchmark the fees against similar retirement plans (by number of employees and plan assets, for example) to see if they’re reasonable. Your 401(k) provider should be able to assist you with the benchmarking process or you may wish to use other industry resources such as the 401k Averages Book. What are the main types of fees? Typically, 401(k) fees fall into three categories: administrative fees, individual service fees, and investment fees. Let’s dig a little deeper into each category: Plan administration fees—Paid to your 401(k) provider, plan administration fees typically cover 401(k) set-up fees, as well as general expenses such as recordkeeping, communications, support, legal, and trustee services. These costs are often assessed as a flat annual fee. Investment fees—Investment fees, typically assessed as a percentage of assets under management, may take two forms: fund fees that are expressed as an expense ratio or percentage of assets, and investment advisory fees for portfolio construction and the ongoing management of the plan assets. Betterment, for instance, acts as investment advisor to its 401(k) clients, assuming full fiduciary responsibility for the selection and monitoring of funds. And as is also the case with Betterment, the investment advisory fee may even include personalized investment advice for every employee. Individual service fees—If participants elect certain services—such as taking out a 401(k) loan—they may be assessed individual fees for each service. Wondering what you and your employees are paying in 401(k) fees? Fund fees are detailed in the funds’ prospectuses and are often wrapped up into one figure known as the expense ratio, expressed as a percentage of assets. Other fees are described in agreements with your service providers. High quality, low fees Typically, mutual funds have dominated the retirement investment landscape, but in recent years, exchange-traded funds (ETFs) have become increasingly popular in large part because of their lower fees. At Betterment, we believe that a portfolio of ETFs, in conjunction with personalized, unbiased advice, is the ideal solution for today’s retirement savers. Who pays 401(k) fees: the employer or the participant? The short answer is that it depends. As the employer, you may have options with respect to whether certain fees may be allocated to plan participants. Expenses incurred as a result of plan-related business expenses (so-called “ settlor expenses”) cannot be paid from plan assets. An example of such an expense would be a consulting fee related to the decision to offer a plan in the first place. Other costs associated with plan administration are eligible to be charged to plan assets. Of course, just because certain expenses can be paid by plan assets doesn’t mean you are off the hook in monitoring them and ensuring they remain reasonable. Plan administration fees are often paid by the employer. While it could be a significant financial responsibility for you as the business owner, there are three significant upsides: Reduced fiduciary liability—As you read, paying excessive fees is a major source of fiduciary liability. If you pay for the fees from a corporate account, you reduce potential liability. Lowered income taxes—If your company pays for the administration fees, they’re tax deductible! Plus, you can potentially save even more with the new SECURE Act tax credits for starting a new plan and for adding automatic enrollment. Increased 401(k) returns—Do you take part in your own 401(k) plan? If so, paying 401(k) fees from company assets means you’ll be keeping more of your personal retirement savings. Fund fees are tied to the individual investment options in each participant’s portfolio. Therefore, these fees are paid from each participant’s plan assets. Individual service fees are also paid directly by investors who elect the service, for example, taking a plan loan. How can you minimize your 401(k) fees? Minimizing your fees starts with the 401(k) provider you choose. In the past, the price for 401(k) plan administration was quite high. However, things have changed, and now the era of expensive, impersonal, unguided retirement saving is over. Innovative companies like Betterment now offer comprehensive plan solutions at a fraction of the cost of most providers. Betterment combines the power of efficient technology with personalized advice so that employers can provide a benefit that’s truly a benefit, and employees can know that they’re invested correctly for retirement. No hidden fees. Maximum transparency. Costs are often passed to the employee through fund fees, and in fact, mutual fund pricing structures incorporate non-investment fees that can be used to pay for other types of expenses. Because they are embedded in mutual fund expense ratios, they may not be explicit, therefore making it difficult for you to know exactly how much you and your employees are paying. In other words, most mutual funds in 401(k) plans contain hidden fees. At Betterment, we believe in transparency. Our use of ETFs means there are no hidden fees, so you and your employees are able to know how much you’re paying. Plus, our pricing structure unbundles the key offerings we provide—advisory, investment, record keeping, and compliance—and assigns a fee to each service. A clearly defined fee structure means no surprises for you—and more money working harder for your employees. -
401(k) Plans for Small Businesses
401(k) Plans for Small Businesses When deciding on employee benefits, more employers are recognizing the importance of financial wellness and how it attracts and retains top talent. Health insurance. Bonuses. Cold brew on tap. Retirement plans. Free lunch Fridays. Ping pong tables. Nap pods. When it comes to employee benefits, there’s a lot to consider. Some perks clearly outrank others, but when deciding what to offer, it can be hard to determine which are right for your small business. But these days, more employers are recognizing the importance of helping their employees save for their future. Not only does having a savings plan make a company more attractive to candidates in today’s tight market, but there is a larger societal issue at play. Approximately 40% of Americans do not have access to a workplace savings plan, meaning they will likely not have enough to retire comfortably. In light of this, many states have passed legislation mandating that employers offer a retirement savings plan such as a 401k plan. (See more later in this article about the state plans.) And don’t forget about your own future! As a small business owner, you may believe that the profits you earn will help you live comfortably in retirement. However, you know that life can change in an instant. Setting aside money in a convenient, tax-advantaged 401(k) plan, can help ensure you’ll live the life you envision. So you may be asking yourself: “Should my small business offer a 401(k) plan?” Many times small business owners believe a 401(k) is too expensive and time-consuming, but that couldn’t be further from the truth. 5 Common Myths about 401(k)s for Small Businesses Let’s take a moment to dispel some of the most common misconceptions about small business 401(k) plans: “It’s Too Expensive!” Traditionally, the price for a 401(k) plan could be quite high and complex. However, times have changed. Innovative providers like Betterment now offer comprehensive plan solutions at costs that are well below the industry average. Plus, small businesses may be eligible for up to $16,500 in valuable tax credits (see more below). “It’s Too Time-Consuming!” Managing every detail of your 401(k) plan by yourself could be extremely onerous, but choosing an experienced partner who can handle everything from plan design to compliance testing means that you can focus on running your business—not worrying about your 401(k) plan. “I’m Afraid of the Legal Ramifications!” The legal responsibilities are real, but many providers assume various levels of investment and/or administrative fiduciary responsibility that dramatically limit your risk exposure. “I’m Not Sure My Employees Will Participate!” Participation is more popular than you may think! In fact, according to the latest survey from the Plan Sponsor Council of America, more than 84.9% of employees are contributing to their 401(k)s. Plus, plan enhancements like automatic enrollment have helped drive participation by combating employee inertia.1 And lower-salaried employees may be entitled to as much as $2,000 thanks to the little-known Saver’s Credit. “We Can’t Afford to Offer a Match!” Matching and profit-sharing contributions are totally optional. Even if your company can’t afford to kick in extra contributions, you can still offer your employees the convenience and tax savings of a 401(k) plan. And if you do decide to offer an employer match in the future, you can deduct those contributions on your taxes! Three Benefits Employers Get From Offering a 401(k) You probably know a 401(k) plan is great for employees, but did you know it’s great for employers, too? Here are the top three ways small businesses benefit by offering a 401(k) plan: Attract and retain talented employees: According to a Betterment for Business survey, 67% of plan participants said that a good 401(k) plan was very important or important in their evaluation of a job offer. Plus, you can consider perks like an employer match to make the plan even more compelling for current and prospective employees. Improve employee satisfaction (and productivity): Many studies have shown that personal financial stress negatively impacts employees’ performance, productivity, and ability to focus—all of which can lead to higher employee turnover. But a 401(k) combined with financial guidance can go a long way toward helping your employees reduce their financial stress. Enjoy valuable tax advantages: To help motivate employers with fewer than 100 employees to offer a retirement plan, the IRS grants some valuable tax benefits. Some of these were added or increased as part of the recent passage of the SECURE Act in December 2019. A tax credit of up to $15,000 over three years to help defray 401(k) start-up costs A tax credit of up to $1,500 over three years for adding automatic enrollment Tax deductions for employer matching or profit-sharing contributions Want to know more about these tax advantages? Talk to your tax advisor or 401(k) plan provider. The 401(k) Costs to Consider Historically, 401(k)s fee structures have been notoriously complex, often with embedded fees to compensate the many players involved. With renewed focus on fees and the entrance of newer 401(k) providers, fees today can be lower and more transparent. Fees are usually shared between employees and employers, so it’s important to look at how fees are assessed and their impact. Fees typically include an annual administrative fee, a per employee fee, and investment management and/or fund fees, usually expressed as a percentage of assets and deducted from employee accounts. Although it can be tempting to choose the provider with the lowest fee, it’s important to understand and evaluate the value provided to you and your employees. Making a wrong decision could mean you will be looking for a new 401(k) provider again in the very near future, which is a distraction to your business. What About the State Programs? Several states, including California, Illinois, Oregon, and others, have passed legislation mandating that employers offer a savings program to their employees. States differ in terms of the size of companies impacted by the mandate, but this trend reflects a growing concern among state governments that more needs to be done to address the issue. The state programs represent potential alternatives to a 401(k); however, they differ from 401(k)s in several important ways: Lower Contribution Limits Because the state programs are Roth IRAs, the maximum allowable contribution limits are much lower than for 401(k)s. For instance, annual contribution limits for those under 50 are just $6,000 for the state programs versus $19,500 for 401(k)s). For those 50 and over, the limits are $7,000 and $25,000 respectively. Lower Income Limits Because Roth IRAs are governed by federal guidelines on income limits, business owners and highly compensated may be restricted from how much they can save (or be prohibited from saving anything at all). To be eligible, married filers can have a joint income of no more than $206,000 and single filers can have an income of no more than $139,000. No Flexibility in Terms of Features and Investment Options A 401(k) can be designed to address the unique needs of a given employee demographic or industry, thereby enabling employers to differentiate their benefits package to attract and retain talent. This flexibility includes plan features like loans and employer contributions, neither of which is part of the state IRA programs. No Employer Tax Credits the recently-passed SECURE Act increased the attractiveness of 401(k)s, thanks to increased tax credits available to small employers. The maximum tax credit is $16,500 over 3 years. No such tax credit is available for companies that adopt the state-mandated plans. State-mandated Roth IRA programs are a step in the right direction, but you should consider all of your options when it comes to offering your employees a benefit that will make a real difference for their future. Given their added flexibility and the ability for employees (and business owners) to save more, 401(k)s have the potential to bring greater value to both your employees and your organization. 3 Steps to Getting your 401(k) Up and Running If you’re considering offering a 401(k) plan to your employees, you may be wondering how to get started. Well, the process is relatively simple: First, select your 401(k) plan provider. How do you figure out who to choose? Be sure to ask detailed questions about their onboarding process, fees, investments, customer support, employee experience and more. Second, set up your plan. If you elect an experienced 401(k) provider, the onboarding process should be easy. You’ll likely have to fill out some paperwork, connect your payroll, and complete a few other straightforward tasks. Third, encourage your employees to start saving as soon and as much as they can. By communicating with your employees, you can help them understand the benefits of having a retirement account. Plus, if you elect automatic enrollment, it’s even easier to help your employees save for their financial future. Deciding to offer a 401(k) plan is an important decision and one that has the potential to impact the lives of your employees in a significant way. We encourage all small business owners to understand the benefits of starting up a 401(k) for their employees and to be a part of helping more Americans save for their future. 1.PSCA: 401(k) participation up, as well as contributions The information provided is education only and is not investment or tax advice. -
Basics of a 401(k) Plan
Basics of a 401(k) Plan Today’s 401(k)s hold more than $5.9 trillion in assets with over 100 million people contributing. But what is a 401(k) and would your company benefit from one? Since the 1980s, the 401(k) has rapidly become the retirement plan of choice for companies across the United States. In fact, today’s 401(k)s hold more than $5.9 trillion in assets and more than 100 million people have contributed. But what exactly is a 401(k)—and would your company benefit from offering one? Let’s start with the basics. How Does a 401(k) Work? Contributions A 401(k) plan is an employer-sponsored retirement savings plan that enables employees to contribute a portion of their paycheck to a tax-advantaged retirement account. In 2020, employees can contribute up to $19,500 to their 401(k), and if they’re age 50 or older, they can make additional catch-up contributions of up to $6,500. Under IRS guidelines, employees may make two types of 401(k) contributions: Traditional and Roth. All plans offer Traditional 401(k) contributions, and many also offer Roth 401(k) contributions. Here’s how they compare: Traditional 401(k) contributions are made with pre-tax dollars. This means that contributions are deducted directly from employee paychecks before income taxes are withheld. The money contributed to the plan—and any associated earnings—grow tax-deferred until employees withdraw it, typically in retirement. At that time, withdrawals are considered ordinary income and employees will pay federal and possibly state taxes depending upon where they live. If they want to withdraw money before they turn age 59 ½, they’ll also be subject to a 10% penalty unless they qualify for an exception. Roth 401(k) contributions are made with post-tax dollars. This means that the money is deducted from employee paychecks after tax dollars have been withheld. Because they already paid their taxes, employees can withdraw contributions—and any earnings—tax-free if they’re age 59 ½ or older and have held their Roth 401(k) account for at least five years. (Unlike a Roth IRA, there are no income limits for participating in a Roth 401(k). Investments Employees can invest their contributions in a range of options. For guidance on investment choices, talk to your 401(k) provider or financial advisor. When thinking about your investment offering, ask these questions: Does our investment offering provide employees with enough choice? Are our investments cost-effective? For example, does the line-up include indexed mutual or exchange-traded funds? Do we default employees into or at the very least offer diversified portfolios for those who don’t want to choose their own funds? Enrollment As an employer, you decide on the eligibility and enrollment methodology. Typically, it is handled in the following ways: Anytime enrollment – Some employers allow both new and existing employees to enroll in the 401(k) retirement plan at any time, including as soon as they’re hired. Conditional enrollment – Some employers require employees to work a certain number of hours or days before becoming eligible to participate. For example, they may require employees be 21 years old and have one year of service before enrolling in the plan. Open enrollment – Some companies only allow employees to enroll in the 401(k) plan during certain defined time frames, such as during a month-long open enrollment period at the end of the year. Automatic enrollment – To encourage employees to save, many employers also include an auto-enrollment feature. With this feature, employees are automatically enrolled in the plan at a certain contribution percentage. For example, employees may be enrolled at a 3% contribution rate. Of course, employees can always opt out before or after they’re automatically enrolled in the 401(k) plan. Which IRS Requirements Should You Know About? Because 401(k) plans offer valuable tax advantages, the IRS has a very strict set of requirements that you must follow. For example, employee contributions made under the plan must meet specific nondiscrimination requirements. To ensure that your plan satisfies these requirements, you must perform annual tests verifying that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees. In addition, the IRS has specific regulations on participation, automatic enrollment, contribution limits, vesting, distributions, and many other aspects of 401(k)s. Wondering how to navigate the rules and regulations? A qualified 401(k) plan provider like Betterment can help you take care of all the details. Five questions to ask 401(k) providers It’s important to choose a provider that not only offers a comprehensive 401(k) solution, but also acts in the best interests of you and your employees. That’s because partnering with the wrong 401(k) provider can leave you vulnerable to high fees, poor investment options, unanticipated administrative burdens, low plan utilization, and misunderstood legal liability. Here are five important questions to ask a prospective retirement plan provider: How is fiduciary liability allocated between you and the plan? Do you provide dedicated support and what kind of 401(k) experience does your staff have? What are the total fees and are they explicitly expressed, rather than embedded in expense ratios? How do you help me stay on top of my compliance requirements? How do you help employees make the most of the plan? At Betterment, we welcome these important questions and invite you to compare our responses with those of our competitors. Find out how we can offer you a better 401(k) plan today. How Much Does a 401(k) Cost? When you think about offering a 401(k) plan, a primary consideration is cost—both for your company and your employees. That’s because fees can eat away at returns over time, taking a serious bite out of employees’ retirement accounts. Although it’s common for certain costs to be paid by participants, it’s a good idea to understand how the total costs will impact them. The main types of expenses associated with a 401(k) plan include: Fund fees Investment management fees Administration and compliance fees Transaction fees Recordkeeping fees Fees are typically assessed in the following ways: Asset-based: Expenses are based on the amount of assets in the plan, represented as percentages or basis points. Per-person/per-participant: Expenses are based upon the number of eligible employees or actual participants in the plan. Transaction-based: Expenses are based on the execution of a particular plan service or transaction. Often, expenses are made up of a combination of asset-based and per-participant fees. With asset-based fees, employees with higher balances pay more. With per-participant fees, all employees pay the same amount—therefore, employees with lower balances pay a higher percentage of their account assets (and those with higher balances pay a lower percentage). So as you think about a fee structure, carefully review fees on both a dollar basis and an asset percentage basis, and consider how growth in employees or assets may impact those numbers. Historically, however, 401(k)s have had complex fee structures. While fund fees are understandably netted from fund returns, plan providers may also route payments for other services through investment returns. This embedding of fees, while legal and reported, can be difficult for employers and employees to understand and track. According to the Investment Company Institute, the average fee for plans with $1 million to $10 million in assets is 1.17 percent. At Betterment, our fees are often well below industry average. Plus, we’re always explicit about our pricing. A clearly defined fee structure means no surprises for you—and more money working harder for your employees. How Does a 401(k) Benefit Employees (and Employers)? A 401(k) plan offers many valuable benefits for employees and employers alike. For employees, top benefits include: Convenience—Automatic payroll deductions make it easy for employees to invest for retirement—and potentially grow their money over time. Matching contributions—Many companies elect to include an employer match to help encourage employees to save (for example, 50 cents on the dollar, up to 6%). Earning “free money” is a top perk for employees. Tax advantages—Whether employees decide to save on a pre-tax basis, post-tax basis, or both, they enjoy valuable tax benefits, which can benefit their bottom line. For employers, top benefits of offering a 401(k) plan include: Talent recruitment and retention—Many employees expect a 401(k) plan to be part of their benefit package—and perks like matching contributions are powerful incentives to join (or stay with) a company. Tax advantages—You may be eligible for an annual $500 tax credit, and any employer contributions you make to your employees’ 401(k) accounts are tax-deductible. A stronger, more productive workforce—According to a study from Prudential, every year an employee delays retirement can cost their employer more than $50,000 due to a combination of factors including higher relative salaries and higher health care costs. A solid 401(k) plan can help ease employees’ financial stress—and help them with saving for retirement. As you can see, a 401(k) plan offers significant benefits, but is it right for your company? Betterment can help you understand the fine points of 401(k) plans and make an educated decision. -
Betterment for Business: A Better 401(k) for Employers and Employees
Betterment for Business: A Better 401(k) for Employers and Employees Betterment’s 401(k) provides personalized investment advice for all plan participants. The era of expensive, impersonal, unguided retirement saving is over. Since Betterment launched in 2010, our mission has been to improve the way people save and invest through smarter technology. For individual investors, Betterment offers automated investing and personalized advice based on specific goals, such as retirement, college savings, or building wealth. For financial advisors, Betterment for Advisors provides an automated service so that advisors can increase efficiency and spend more time building relationships with their clients. Betterment for Business helps people save and invest in workplace 401(k)s. While the number of U.S. adults enrolled in 401(k) plans has grown quickly, roughly half of Americans don’t work for an employer that sponsors a retirement savings plan. The main reason: The plans are too expensive and too time-consuming for their employers to implement. People who do have employer-sponsored plans don’t always have it much better. No matter how little the funds cost, typical plans often offer little guidance, can be hard to navigate, and may not be personalized to the employee’s circumstances and goals. Meanwhile, employers want to manage the costs, risks and administrative burden of providing a plan. We wanted something better. So we built it. Betterment for Business combines the power of efficient technology with personalized advice so that employers can provide a benefit that’s truly a benefit, and employees can know that they’re invested correctly for retirement. The era of expensive, impersonal, unguided retirement saving is over. The Traditional 401(k) Landscape: Confusing and Expensive Even before we started Betterment for Business, we knew that the system was broken. But we didn’t realize how bad it was until we were searching for our own plan. High-Cost and Tedious for Employers In 2014, we set out to find the best 401(k) plan for Betterment employees. We wanted to offer this benefit to help our team save for retirement and to help us attract and retain good talent; in a recent survey of Betterment 401(k) participants, 67% said that a good 401(k) was very important or important in their evaluation of a job offer. But as we explored the 401(k) landscape, we were faced with a myriad of confusing options that included mountains of paperwork and ongoing administrative and compliance duties. While we were lucky to be in the business of investing and have experts to rely on, for the average employer, setting up a 401(k) for the first time can be akin to navigating the Wild West. And then there were the fees. As we talked to our fellow employers who were in a similar position, it seemed like not one person could answer what I had at one point thought was a simple question: “How much does your 401(k) cost you and your employees?” As it turns out, it’s not that simple. Why are Most 401(k) Plans So Expensive? Most people might guess that the way 401(k) fee structure works is: The employer pays the fee to a plan provider to administer a 401(k). The employee pays fund fees, which are just the costs of the fund manager. But it turns out that most of the time, 401(k) fees are much more complicated than that. The graphic below from a Deloitte study breaks down the service providers involved in generating plan costs. There are actually quite a few moving parts, most of which are done by hidden third parties, all of whom have to integrate with each other. All that coordination and friction drives up costs, not to mention the potential for errors in plan administration. Why do all these middlemen exist? And what exactly do they do? Most of them exist as a result of the ever-changing workplace retirement landscape that has developed over the past several decades. Similar to the healthcare industry, many providers have legacy processes and technology that would be unlikely to exist if you were designing it from scratch today. It wasn’t all that long ago that 401(k)s didn’t even exist. And in fact, they came about almost by accident in 1978 when Congress passed a provision that allowed employees to avoid being taxed on deferred compensation. In 1980, a benefits consultant relied on this provision to create a retirement plan that enabled employees to save on taxes, and in 1981, the IRS allowed 401(k)s to be funded via payroll deduction, leading to the phenomenal growth in 401(k) plans nationwide. As the 401(k) market grew in the 1990s, competition for services increased. Plan sponsors could bid for the best recordkeeper, the best investment manager, the best participant communications firm, and any other third-party service they wanted. All of this competition led to an increase in the number of financial services companies entering the 401(k) marketplace. Meanwhile, new regulations kept coming: 404(c), the Economic Growth and Tax Relief Reconciliation Act of 2001, Sarbanes-Oxley Act of 2002, and The Pension Protection Act of 2006, among others. With each new regulation came an additional set of compliance requirements, and more companies sought to provide solutions to employers to help meet the increasing demands. But more providers only continued to complicate the picture, adding a web of specialized services, each charging a fee that increases 401(k) costs and results in lower investment returns for the plan participant. Unfortunately, retirement saving isn’t optional for most Americans. And one of the best ways to save is in a tax-deferred account. But with so much compliance regulation and so many players involved in the process, the industry has made most 401(k)s more expensive than they have to be. Hidden Fees These costs are often passed to the employee through fund fees, and in fact, mutual fund pricing structures incorporate non-investment fees that can be used to pay for other types of expenses. Because they are embedded in mutual fund expense ratios, they may not be not explicit, thereby making it difficult for employees and employers to know exactly how much they’re paying. In other words, most mutual funds in 401(k) plans contain hidden fees. At Betterment, we believe in transparency. Our use of exchange-traded funds (ETFs) means there are no hidden fees, so you and your employees are able to know how much you’re paying. How Do These Fees Affect Employees? Differences between low-cost and high-cost investments can have a significant impact on an individual’s standard of living in retirement. In fact, according to Nobel Prize winner William Sharpe, “a person saving for retirement who chooses low-cost investments could have a standard of living throughout retirement more than 20% higher than that of a comparable investor in high-cost investments.” This means that a 401(k) plan is less of an “employee benefit” if it means employees are paying high fees. In another study, a two-earner household at the median income level and paying typical 401(k) fees loses 30% of their savings, or $154,794, to fees over the course of 40 years of retirement savings. A higher-income household can expect to pay an even steeper price. Employees Need More Guidance Fees are not the only downside of many existing 401(k) plans; even with low-fee funds, the typical experience can still be sub-par and difficult to navigate. When employees enroll in a 401(k) plan, they often ask questions like, “Which funds should I pick?” “Should I roll over previous 401(k) assets to this new plan or an IRA?” “Should I save in a Roth or Traditional account?” And perhaps most importantly, “Am I saving the right amount?” Solid retirement readiness comes from saving in the right types of accounts, at the right rate, across your household, and maximizing employer matches. It can be amplified by embedding tax rate diversification, making the most of how Roth and Traditional accounts are taxed now, versus in retirement. We realized that funds alone, no matter how low cost they were, would not entirely solve the problem that employees were not receiving the guidance and the advice they deserved. Holistic, and Personalized Advice for Every Employee With Betterment for Business, employees can use our built-in retirement planning advice to get personalized guidance on their retirement goals from a completely holistic view. Combining your employees’ 401(k)s—both Roth and Traditional—IRAs, and any taxable retirement savings, our guidance tools tell employees how much they should save to have a comfortable retirement based on a number of factors: Whether they’re married Where they live Where they plan to retire What their income is like What their current savings are with other providers Even their spouse’s holdings. By capturing all of these elements of life to help plan for life’s major goal of retirement, our guidance can help employees get on track with their savings and plan what accounts they may need to do so. Underneath the surface, the advice informs which specific portfolio we recommend to participants and how that portfolio allocation adjusts over time to the appropriate risk level. Remember, the tools are automatically built into every employee’s experience using the Betterment 401(k). CITATIONS 1 https://www.businesswire.com/news/home/20150826005265/en/Schwab-Survey-Finds-People-Prioritize-Wealth-Health#.VeeQyNNVikq 2 https://www.ici.org/pdf/rpt11dc401kfee_study.pdf 3 https://www.ici.org/pdf/ppr15dcplanprofile401k.pdf 4 https://www.demos.org/press-release/new-report-hidden-excessive-401k-fees-cost-retirees-155000 -
Understanding 401(k) Nondiscrimination Testing
Understanding 401(k) Nondiscrimination Testing Discover what nondiscrimination testing is (and how to pass) If your company has a 401(k) plan—or if you’re considering starting one in the future—you’ve probably heard about nondiscrimination testing. But what is it really? And how do you help ensure your plan passes these important compliance tests? Read on for answers to the most frequently asked questions about nondiscrimination testing. What is nondiscrimination testing? Mandated by ERISA, annual nondiscrimination tests help ensure that 401(k) plans benefit all employees—not just business owners or highly compensated employees (HCEs). Because the government provides significant tax benefits through 401(k) plans, it wants to ensure that these perks don’t disproportionately favor high earners. We’ll dive deeper into nondiscrimination testing, but let’s first discuss an important component of 401(k) compliance: contribution limits. What contribution limits do I need to know about? Because of the tax advantages afforded 401(k) plan contributions, the IRS puts a limit on the amount that employers and employees can contribute. Here’s a quick overview of the important limits: Limit What is it? Notes for 2021 plan year Employee contribution limits (“402g”) Limits the amount a participant may contribute to the 401(k) plan. The personal limit is based on the calendar year.1 Note that traditional (pre-tax) and Roth (post-tax) contributions are added together (there aren’t separate limits for each). $19,500 is the maximum amount participants may contribute to their 401(k) plan for 2021. Participants age 50 or older during the year may defer an additional $6,500 in “catch-up” contributions if permitted by the plan. Total contribution limit (“415”) Limits the total contributions allocated to an eligible participant for the year. This includes employee contributions, all employer contributions and forfeiture allocations. Total employee and employer contributions cannot exceed total employee compensation for the year. $58,000 plus up to $6,500 in catch-up contributions (if permitted by the plan) for 2021. Cannot exceed total compensation. Employer contribution limit Employers’ total contributions (excluding employee deferrals) may not exceed 25% of eligible compensation for the plan year. N/A This limit is an IRS imposed limit based on the calendar year. Plans that use a ‘plan year’ not ending December 31st base their allocation limit on the year in which the plan year ends. This is different from the compensation limits, which are based on the start of the plan year. Adjusted annually; see most recent Cost of Living Adjustments table here. What is nondiscrimination testing designed to achieve? Essentially, nondiscrimination testing has three main goals: To measure employee retirement plan participation levels to ensure that the plan isn’t “discriminating” against lower-income employees (NHCEs) or favoring HCEs. To ensure that people of all income levels have equal access to—and awareness of—the company’s retirement plan. To encourage employers to be good stewards of their employees’ futures by making any necessary adjustments to level the playing field (such as matching employees’ contributions) How do I classify my employees by income level? And what do all these acronyms really mean? Before you embark on nondiscrimination testing, you’ll need to categorize your employees by income level and employee status. Here are the main categories (and acronyms): Highly compensated employee (HCE)—According to the IRS, an employee who meets one or more of the following criteria: Prior (lookback) year compensation—Earned over $130,000 in 2020; some plans may limit this to the top 20% of earners in 2020 (known as the top-paid group election); or Ownership in current or prior year—Owns more than 5% of (1) outstanding corporate stock, (2) voting power across corporate stock, or (3) capital or profits of an entity not considered a corporation Non-highly compensated employee (NHCE)—Someone who does not meet the above criteria. Key employee—According to the IRS, an employee who meets one or more of the following criteria during the plan year: Ownership over 5%—Owns more than 5% of (1) outstanding corporate stock, (2) voting power across corporate stock, or (3) capital or profits of an entity not considered a corporation. Ownership over 1%—Owns more than 1% of the stock, voting power, capital, or profits, and earned more than $150,000. Officer—An officer of the employer who earned more than $185,000 for 2021; this may be limited to the lesser of 50 officers or the greater of 3 or 10% of the employee count. Non-key employee—Someone who does not meet the above criteria. What are the nondiscrimination tests that need to be performed? Below are the tests typically performed for 401(k) plans. Betterment will perform each of these tests on behalf of your plan and inform you of the results. 1. 410(b) Coverage Tests—These tests determine the ratios of employees eligible for and benefitting from the plan to show that the plan fairly covers your employee base. Specifically, these tests review the ratio of HCEs benefitting from the plan against the ratio of NHCEs benefitting from the plan. Typically, the NHCE percentage benefitting must be at least 70% or 0.7 times the percentage of HCEs considered benefitting for the year, or further testing is required. These annual tests are performed across different contribution types: employee contributions, employer matching contributions, after-tax contributions, and non-elective (employer, non-matching) contributions. 2. Actual deferral percentage (ADP) test—Compares the average salary deferral of HCEs to that of non-highly compensated employees (NHCEs). This test includes pre-tax and Roth deferrals, but not catch-up contributions. Essentially, it measures the level of engagement of HCEs vs. NHCEs to make sure that high income earners aren’t saving at a significantly higher rate than the rest of the employee base. Specifically, two percentages are calculated: HCE ADP—The average deferral rate (ADR) for each HCE is calculated by dividing the employee’s elective deferrals by their salary. The HCE ADP is calculated by averaging the ADR for all eligible HCEs (even those who chose not to defer). NHCE ADP—The average deferral rate (ADR) for each NHCE is calculated by dividing the employee’s elective deferrals by their salary. The NHCE ADP is calculated by averaging the ADR for all eligible NHCEs (even those who chose not to defer). The following table shows how the IRS limits the disparity between HCE and NHCE average contribution rates. For example, if the NHCEs contributed 3%, the HCEs can only defer 5% (or less) on average. NHCE ADP HCE ADP 2% or less → NHCE% x 2 2-8% → NHCE% + 2 more than 8% → NHCE% x 1.25 3. Actual contribution percentage (ACP) test—Compares the average employer contributions received by HCEs and NHCEs. (So this test is only required if you make employer contributions.) Conveniently, the calculations and breakdowns are the same as with the ADP test, but the average contribution rate calculation includes both employer matching contributions and after-tax contributions. 4. Top-heavy determination—Evaluates whether or not the total value of the plan accounts of “key employees” is more than 60% of the value of all plan assets. Simply put, it analyzes the accrued benefits between two groups: Key employees and non-Key employees. A plan is considered top-heavy when the total value (account balance with adjustments related to rollovers, terminated accounts, and a five-year lookback of distributions) of the Key employees’ plan accounts is greater than 60% of the total value (also adjusted as noted above) of the plan assets, as of the end of the prior plan year. (Exception: The first plan year is determined based on the last day of that year). If the plan is considered top-heavy for the year, employers must make a contribution to non-key employees. The top-heavy minimum contribution is the lesser of 3% of compensation or the highest percentage contributed for key employees. However, this can be reduced or avoided if no key employee makes or receives contributions for the year (including forfeiture allocations). What happens if my plan fails? If your plan fails the ADP and ACP tests, you’ll need to fix the imbalance by returning 401(k) plan contributions to your HCEs or by making additional employer contributions to your NHCEs. If you have to refund contributions, affected employees may fall behind on their retirement savings—and that money may be subject to state and federal taxes! If you don’t correct the issue in a timely manner, there could also be a 10% penalty fee and other serious ramifications. Why is it hard for 401(k) plans to pass nondiscrimination testing? It’s actually easier for large companies to pass the tests because they have many employees at varying income levels contributing to the plan. However, small and mid-sizes businesses may struggle to pass if they have a relatively high number of HCEs. If HCEs contribute a lot to the plan, but non-highly compensated employees (NHCEs) don’t, there’s a chance that the 401(k) plan will not pass nondiscrimination testing. How can I help my plan pass the tests? It pays to prepare for nondiscrimination testing. Here are a few tips that can make a difference: Make it easy to enroll in your plan—Is your 401(k) plan enrollment process confusing and cumbersome? If so, it might be stopping employees from enrolling. Consider partnering with a tech-savvy provider like Betterment that can help your employees enroll quickly and easily—and support them on every step of their retirement saving journey. Learn more now. Encourage your employees to save—Whether you send emails or host employee meetings, it’s important to get the word out about saving for retirement through the plan. That’s because the more NHCEs that participate, the better chance you have of passing the nondiscrimination tests. (Plus, you’re helping your staff prioritize their future.) Add automatic enrollment —By adding an auto-enrollment feature to your 401(k) plan, you can automatically deduct elective deferrals from your employees’ wages unless they elect not to contribute. It’s a simple way to boost participation rates and help your employees start saving. Add a safe harbor provision to your 401(k) plan—Avoid these time-consuming, headache-inducing compliance tests all together by electing a safe harbor 401(k) plan. What’s a safe harbor 401(k) plan? A safe harbor 401(k) plan is a defined contribution retirement plan that’s exempt from nondiscrimination testing. It’s like a typical 401(k) plan except it requires you to contribute to the plan on behalf of your employees, sometimes as an incentive for them to save in the plan. This mandatory employer contribution must vest immediately—rather than on a graded or cliff vesting schedule. This means your employees can take these contributions with them when they leave, no matter how long they’ve worked for the company. To fulfill safe harbor plan requirements, you can elect one of the following contribution formulas: Basic safe harbor match—Employer matches 100% of employee contributions, up to 3% of their compensation, plus 50% of the next 2% of their compensation. Enhanced safe harbor match—Employer matches 100% of employee contributions, up to 4% of their compensation. Non-elective contribution—Employer contributes 3% of each employee’s compensation, regardless of whether they make their own contributions. These are only the minimum contributions. You can always increase non-elective or matching contributions to help your employees on the road to retirement. Interested in adding a safe harbor provision to your 401(k) plan? Find out more now. Did You Know? As a result of the SECURE Act, any 401(k) plan not utilizing a safe harbor match can be amended as late as 30 days before a plan year-end to provide the 3% safe harbor nonelective contribution for the plan year. How can Betterment help? We know that nondiscrimination testing and many other aspects of 401(k) plan administration can be complicated. That’s why we do everything in our power to help make it easier for you as a plan sponsor. In fact, we help with year-end compliance testing, including ADP/ACP testing, top-heavy testing, annual additions testing, deferral limit testing, and coverage testing. With our intuitive online platform, you can better manage your plan and get the support you need along the way. Plus, you can have it all for a fraction of the cost of other 401(k) providers. Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise. The information contained in this article is meant to be informational only and does not constitute investment or tax advice.